How do you align your DCF terminal value assumptions with your strategic goals or objectives?

“Moreover, the growth rate should reflect your strategic goals or objectives, such as expanding into new markets, launching new products, or improving operational efficiency.” This is not a good argument. The terminal growth rate is implying a perpetuity. Whatever growth rate is chosen, then it applies to infinity. That means that at some point regardless of the strategy that the company is going to adopt it will be drowned out by infinity. To better better capture this will be to expand the forecast period. This way this strategy is more accurately captured. Of course that opens the issue of forecasting for a longer period, which becomes more tea leaf reading…

1- Growth Rates: Set terminal growth rates that reflect long-term strategic objectives. 2- Margin Assumptions: Project stable margins aligned with efficiency targets. 3- Reinvestment Rates: Assume reinvestment consistent with planned capital intensity. 4- Discount Rates: Adjust for risk aligned with strategic initiatives. 5- Sensitivity Analysis: Test assumptions against various strategic scenarios. 6- Competitive Position: Consider long-term market position and business moat. 7- Industry Trends: Ensure alignment with anticipated industry evolutions. 8- Stakeholder Input: Validate assumptions with management expectations. 9- Consistency: Align terminal value inputs with the story told by the rest of the model.

I just flat out don't believe in using a terminal value based on perpetual growth. Please show me one company that has been around since the dawn of time. More specifically, please show me one production plant that's been around more than 100 years. I believe is setting a realistic number of years for a product, plant, or improvement project. Just for argument's sake, 7 years for a product, 20 years for a plant, and no more than 10 for a project. This shows that new products will replace the one you're working on. Plants will come and go due to various reasons. Projects will eventually be replaced with new ones. Pick a timespan and incorporate exit cost, inventory reduction and shutdown cost.

We can take guidance from different frameworks like the Gartner hype cycle, Market models like Porter's five forces model, and expected margin and volume evolution to find companies that fit the narrative of where we see the project/company in the timeframe when terminal value calculation starts. I would give an indication. Building multiple scenarios of terminal value with different narrative can help a lot to understand the drivers of terminal value

DCF is like a martial art. it needs a lot of discipline and sticking to the rules, while being creative in the narrative. A narrative of what the market/ environment was, what it is, and how it could be a good starting point for a DCF exercise and also when communicating the findings. Next could be how each of these translates into certain assumptions in terms of figures/ranges. Certain actions assumed in the future will tend to change the valuation and their assumptions and effects must be discussed. For example, an expansion in a nascent market could lead to an initial cash outflow, but market leadership. Both will affect the cash flows and growth rate. This will also help marry the strategy with the valuation.

Very briefly - and not trying to be a jerk here - the above largely gets the dynamics of terminal value right, but actually think the question is problematic. In #valuation, one shouldn't be aiming to tailor terminal value assumptions at all. While some inherent bias inevitably sneaks in, what one should never do is effectively "if I set my steady state growth % at X% or set my exit multiple at Y, I get back a value that's consistent with my hurdle rate." Where firm is in its life cycle is a critical area to assess - not to backfill. #valuation #finance