Investment to depreciation ratio in the calculation of the terminal value in business valuation using income approach

Gheorghe Nistoroiu

The Valuation Journal, 2018, vol. 13, issue 2, 89-99

Abstract: The aim of this research is studying the relationship between the investment and depreciation levels used in the calculation of the terminal value by cash flow capitalization applied for business valuation. The analysis relied on a statistical model in Excel, using as variables the net value of fixed assets at the beginning of the perpetuity growth period, the average depreciation period of these assets and the growth rate applied to depreciation, based on which the annual investment is calculated. The analysis led to the conclusion that there was quantitative relationship between the level of depreciation and that of annual investment considered in the calculation of terminal value. Thus, under the assumption of perpetuity growth, it is necessary for investment to exceed depreciation. Consequently, when we calculate the terminal value based on a perpetual growth, the assumption that annual depreciation and investment are equal results in the overestimation of the enterprise value. The extent of the overvaluation depends on the share of the depreciation cost in total costs, on the forecast perpetuity growth rate and on the share of the discounted terminal value in the enterprise value.

JEL-codes: G32 (search for similar items in EconPapers)
Date: 2018
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Persistent link: https://EconPapers.repec.org/RePEc:vaj:journl:v:13:y:2018:i:2:p:89-99

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