Question
Background info: Consider the calculation of the continuation value formula. Suppose Firm C has a WACC of 6%. Firm C's investment banker prepares a DCF
Background info: Consider the calculation of the continuation value formula. Suppose Firm C has a WACC of 6%. Firm C's investment banker prepares a DCF valuation of Firm C using the WACC approach. In her DCF valuation, Firm C's investment banker suggests to use a Firm-Value-to-Noplat multiple of 28 to calculate the continuation value after the explicit forecast period. That is, she suggests that instead of using a formula, one should just multiply Noplat in the year after the explicit forecast period (that is, Noplat in year T+1) by 28 to arrive at the continuation value. Assume that year T+1 is 2029.
Question: Reasonable estimates of Firm C's return on invested capital on new investment (ROIC) for the long-term appropriate for the calculation of the continuation value are between 6% and 8%. Reasonable estimates of the reinvestment rate for Firm C for the long-term appropriate for the calculation of the continuation value range from 30% to 50%. Do you think that under these assumptions the Firm-Value-to-Noplat multiple of 28 is reasonable for the continuation value? Why or why not? Explain your reasoning carefully and show your calculations.
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