The terminal value

This chapter, A Strategy's Value, discusses management considerations on estimating the benefit of a strategy (as part of the strategy formulation process, the subject of this online book), and specifically how to compute value added during the growth phase and when the strategy is mature. The next five pages are the core to discussions on setting stretch goals.

Back to the Story Line

A "boss," recently invited to join the senior management strategy committee, has been asked to recommend to her colleagues the discount rate to use to assess new offerings. We are at the key calculations - when the strategy is fully implemented, what is it worth?

The terminal value, the second part of the formula, represents value of a mature project after implementation. There are very many calculation approaches for the terminal value, two I'll discuss: annuity method and market value to sales ratio. After estimating the terminal value, we discount it to the present value and add it to the NPV of the growth phase to compute value added.

The management considerations about the mature project are will revenues continue to grow (market value to sales ratio) or will its gross margin just pay the debt expenses (annuity method).

Calculate the Terminal Value's Present Value in Excel

For a discount rate of 10%, Excel formula for present value would be:

67.17 =PV(10%,6,0,-119,0)

10% is the discount rate; this is the sixth year; no payments (the NPV calculation accounts for the first five years); 119 is the terminal value (and by convention in the formula, a negative number since we could "sell" the program and withdraw that cash); and finally we'd withdraw that value at the end of sixth year, in the Excel a 0.

How do we determine the terminal value of 119?