The first things here is to select the value of T which is the horizon stating the span of time in the project for detailed financials. The value will value you to substitute the estimate of wholesale terminal value. Let’s discuss the forecast in detail:
- One can predict the cash flows in the future which will be accurate as presented in the term of intermediate.
- The forecast today is not sure to remain the same in future as there may be lesser steep.
Let us understand these points in detail with the help of an example: Let’s say you have the temperature forecast for the month of July next year. Probably the forecast of the same month after 30 years will be similar with minus or plus in 10 degrees approximately. This means if the environment is stable, the uncertainty will not see any growth but the horizon will be stuck at the same level. Now let’s talk about an ice cream store now. If there is change in temperature from minus 10 degrees or plus 10 degrees in the month, you will notice the change in certainty in your business. This means that if you wish to calculate the store value today, the uncertainty in the intermediate time is a topic worry than that of long term.
But in real world there are factors like economics knowledge and strategies that will put a restriction of the profitability in the long term. At some point economic rent will also play the role when the investment return rates will be greater than capital cost and which is achievable only when the firm has valuable assets which are difficult to defeat the mitigation for example Steve Jobs for Apple.
People do have a curiosity to determine when their products will become commodities to general normal profits. In this case, one needs to apply thinking of economics. If the company carries unique resources and products with an updated technology and terms, do not really face barriers at the entry point and thus, it take only few years for them to replace their products as commodities. For example a DVD player which was $800 once and now can be found in $20 after 10 years. And hence, such an example is a proof that the companies which are fast-growing today were not really the same back then. But it entirely depends on the company we are looking into. The economics rents back then was not expected to be earning in the value it is today. One can understand in the courses of business strategy on the decision on the firm to settle for lower growth rate of economics under different labels. Under this strategy, one must pop up the following questions:
- How much time does it take to erode the entrance of barriers
- How much time will it take for the competitors to opt your success
- How much time will it take for your suppliers and customers to squeeze you
By considering the economics of the underlying firms, it will be easier to choose the value of the horizon T. One can achieve the same at the time they will earn ordinary profits by the products. At such a point, the terminal value can be easily predicted. The, move your goal to capture the unstable growth period in the business under the presence of forecast of detailed financials.
Talking about choosing the terminal phase for the business, it is generally considered between 3 to 20 years. The most common period is between 5 to 10 years.