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Compare annuity to market value/sales ratio methods

Before "the boss" set up the Excel formula, she already knew the two results for the value added would not be the same. She suspected market value/sales ratio approach would look better.

  • the market value/sales ratio considers investors' expectations on future sales, forever. Even though it is an industry average, in her experience sales estimates are often optimistic.
  • The annuity method factors in costs of staying competitive in a mature market with lots of competition. Eventually, its value is going to decline.

First calculate the terminal value, then its PV and add that to the NPV of the growth phases to determine the total value added. Note that the industry WACC (10.0%) is used in annuity method and as the discount rate to calculate the PV of the Terminal Value in both methods. Earlier we had calculated the NPV of the growth phase.

               Graphic comparing terminal values computed using the annuity method, 119, to the markets value/sale ratio method, 181

"The boss's" first observation: 99% of the value added using both methods comes from the terminal year - an assumption of about performance in sixth year and beyond. Her readings indicated the 60 to 80% of the value added in most projects comes from the terminal year, but 99% makes this project suspicious using either method. She would question the project's performance the first five years during development, introduction and growth.

Now, she has enough background to ask informed questions, has considered the relationships, and has formed a few opinions.

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