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Technical Note: Value Driver Formulas for Continuing Value in Firm Valuation by the Discounted Cash Flow Model

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  • L. Jennergren

Abstract

A team from McKinsey (Koller et al. 2010) recommended the value driver formula for continuing value. The idea is as follows: The company is almost in a steady state. However, the existing operations and the subsequent ones, referred to as growth projects, can be somewhat different. That is, the return on new invested capital (RONIC; refers to growth projects) can be lower than the return on invested capital (ROIC; refers to existing operations). Two weaknesses are associated with the McKinsey formula. Firstly, the only permissible case of RONIC < ROIC is where the working capital requirement is different between the growth projects and the existing operations. The usual Gordon formula then gives the same result, so the McKinsey formula is not necessary. Secondly, the implied split into existing operations and growth projects means that the former are valued under the unreasonable assumption of zero inflation. A more significant extended value driver formula is derived that rectifies these weaknesses.

Suggested Citation

  • L. Jennergren, 2013. "Technical Note: Value Driver Formulas for Continuing Value in Firm Valuation by the Discounted Cash Flow Model," The Engineering Economist, Taylor & Francis Journals, vol. 58(1), pages 59-70.
    • Handle: RePEc:taf:uteexx:v:58:y:2013:i:1:p:59-70
    DOI: 10.1080/0013791X.2012.729876
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    Cited by:

    1. Rajesh Kumar & Sujit Sukumaran, 2019. "Determinants of Value Creation in Emerging Market Firms ¨C¨C An Empirical Examination," Review of Economics & Finance, Better Advances Press, Canada, vol. 17, pages 79-92, August.

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