If you ask a business appraiser what your company’s value drivers are, he may respond with definitions of the variables found in a net present value formula, or a description of the empirical data used to arrive at the cost of capital, financial leverage, and the rate of earnings growth.
This is because valuation calculations are most affected by small changes in four assumptions:
- The short term growth rate of annual cash flow over a discrete forecast period of 5-10 years
- The long term growth rate of annual cash flow following the discrete forecast period, which is used to estimate what the terminal value, or market value will be at the end of the forecast period.
- The cost of capital expressed as annual rates of return necessary to induce the equity holders and lenders to provide the capital necessary to fund the assets used in production.
- The capital structure, or ratio of debt to equity, at various points in time during the forecast period.