28 Feb Discounted Cash Flow: Income Stream and Period Used
The discounted cash flow method used to find present value of future cash flow and allows for growth in cash flow for the next five years. It then assumes stabilized earnings through perpetuity.
- Predebt net income in year five is used for the terminal value.
- Five years appears to be a generally accepted period of time for growth in the Company to be credited to the current owner in terms of value.
- However, there is nothing concrete about five years. In some situations a longer or shorter time frame may be more appropriate.
- May need longer period if company is cyclical with a eight to ten year cycle to capture the full cycle of the industry. Or if the Company has strong patents or intellectual property on a product that will , take longer than five years to capitalize on.
- May need shorter period if the current operations will not contribute significantly to the future benefit stream such as a construction company that relies solely on competitive bids to obtain work.