When valuing a business that depends on contracts, licenses, or permits for its future cash flows, how do you take into account the risk of nonrenewal? Matthew Gold and Matthew Ashby, who are both with Ferrier Hodgson, have developed a formula that explicitly incorporates the assumed probability of renewal in the valuation of businesses whose cash flow hinges on contracts. The formula builds on the Gordon growth model and the formula for the future value of a growing annuity and has broad application subject to certain conditions being met. “We suggest the mathematical quantification of renewal risk based on an assessment of the probability of contract renewal offers a more intuitive and reliable approach than making subjective adjustments to cash flows, capitalization multiplies, or discount rates to account for the risk of nonrenewal,” the authors say. They explain their methodology in an article in the September 2018 issue of Business Valuation Update. To request a free copy of an Excel workbook demonstrating the use of the formulas in this article, click here. Feedback is welcome!