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Suggested Questions for Arcadian Microarray Essay

Prepare to explain the implications of case Exhibit 1 (Paige Simon’s first task). Based on that exhibit, is terminal value a material component of firm values? Drawing on case Exhibit 4 and your own general knowledge, where would the various estimators be appropriate? Where would they be inappropriate? (Simon’s second task) Regarding the cash flow forecasts in case Exhibit 5, at what point in the future would you set the forecast horizon for the three investments? Why? More generally, what should determine when you stop forecasting annual cash flows and estimate a terminal value? Estimate other terminal values based on alternate estimation approaches.

From these various estimates, please triangulate toward a single composite estimate of terminal value for each of Sierra Capital and Arcadian’s forecasts. What is the resulting present value (PV) of cash flows under Sierra Capital and Arcadian’s outlook? How significant was TV in creating the difference between the two present value estimates? As a general matter in valuation work, how much attention should terminal value garner? What short list of questions about TV could you keep on hand in case a client asked you to opine on a valuation of that company?

Answer:

1. Chu believes that stock price is mostly affected by terminal value. From the exhibit, we can find the PV of five years’ dividends is small part of the market price of the stock. In my opinion, we buy a stock then get dividend periodically, which like buy a bond. The coupon payment is dividend and the face value is terminal value. The bond value is determined by the terminal value mostly. So the stock price is also determined by terminal value. The concept of going concern can explain that Terminal value is often higher than the present value of near term cash flows, which means that a company’s long-term cash-flow capacity is more important. 2. There are 5 methods to estimate terminal value.

First, book value approach is appropriate if it is used when the minimum value of the company needs to be determined, on the other hand, it ignores some assets and liabilities and subjects to accounting manipulation. Second, replacement value is appropriate if it is used when a company deciding whether to buy another company or built new one from scratch. However, it is subjective estimates and the value may be difficult to come by. Third, liquidation value is appropriate to be used when assets are marketable. Despite the advantages of conservative, this method ignores going concern value and has uncertainty about value of assets in the market. Forth, multiples approach is appropriate when it is used as a business valuation benchmark. This method is widely used due to the simpleness, even though, it provides relative value, not the absolute value.

Lastly, discounted cash flow is appropriate to be used when cash flows are strong and relatively consistently. This method reflects the time value of money, on the contrary, errors in growth rate and discount rate can provide improper value 3. In the case of the toll road, the terminal value could be estimated at year 4; for the bottling plant at year 14; and the film studio at year 28. The important key is that the perpetuity growth should be achieved when maturity has been reached. The firm should have completed the high-growth phase of its existence.


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