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The Basics

DCF Key Questions

Combine Action Plans

Key Points

Market value/sales ratio - terminal value

Amram's method estimates the market value in the terminal year by multiplying the industry's historical market value to sale ratio times the terminal year sales (and discounts it to the present using the industry cost of capital). The market value/sales ratio is based on industry historical data, and the industry's WACC is based market expectations.

Her assumption is as a product matures, over the long haul, it should create value for a firm equal to the value the industry creates per dollar of sales. Prof. Damodaran at NYU has datasets to determine an industry market value to sales ratio.

                      Formula for terminal value

For example, in Jan 2003 the US Electrical sector ratio was 2.48, and a company would need "$2.48 in assets to create $1 of sale revenue." If I were buying the company, that would be my expectaion - I'd pay $2.48 to buy a company that would generate $1 in sales in one year. The value added is in the eye of the buyer.

The industry WACC is 10.2%. (I'll use 10% to be consistent with the other examples in this chapter.)

How do the present values of the two methods compare using the industry WACC?

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