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The residual value is based on the expected net cash flow to the firm in the last year of the forecast
in 2013 of $4.533 million. Victoria estimates Acme‟s long-term sustainable earnings growth rate is
5% per year on average. Therefore, she estimates the cash flow for 2014 at $4.760 million ($4.533
million × 1.05). She applies a price multiple of 12 to this cash flow. The calculation for the multiple is
presented in Exhibit 16.11. Therefore, Acme‟s future residual value as of December 31, 2013, is
estimated as $57.1 million. Next, Victoria calculates the present value as of December 31, 2008, of the
residual value as $30.6 million.
The present values of the five years of cash flows are added together along with the present value of
the residual value. The sum of the present values represents Acme‟s business enterprise value of $42.1
million. Next, Acme‟s interest bearing debt of $10.4 million is subtracted, resulting in $31.7 million
for the value of Acme‟s common stock as of December 31, 2008.
Next, Victoria considers whether valuation adjustments should be made to the $31.7 million value.
If Acme were sold, it would probably take months or even longer to sell. The process of selling private
firms is much different than selling marketable securities that generally have an active market. Unlike
marketable securities like public stocks and bonds, the market for private firms is thin and often
requires a team of professional advisers to verify the firm‟s information, perform valuations, draft
legal documents, and so forth. Since the discounted cash flow model Victoria used relies on a discount
rate developed from marketable securities, Victoria will make a valuation discount from the $31.7
million for Acme‟s lack of liquidity.