Competitive Equilibrium

For calculating the value after the horizon, it’s necessary to explain the stability of financial indicators. What does this mean?

NOPAT – must be normalized. This is the basic figure for subsequent projections. Therefore, inadequately high or low figures here can lead to significant errors. The final forecast year’s NOPAT should be based on normalized sales, stable ROIC, and growth. Errors may arise in the case of cyclical companies…

RONIC – should correspond to the industry ROIC, indicating that the organization has entered the competitive phase and has normalized profits. Many argue that at this stage ROIC = WACC, but despite its theoretical correctness, it’s not often the case in practice. This assumption should be tested only after a long period or by using a RAND function where RONIC plays against WACC and industry ROIC;

Growth – should be linked to industry benchmarks. It is very dangerous for an organization to grow faster than the industry over a long period. It is advisable to take into account the inflation trend in the consumption of the industry’s products and add a margin of error (the relevance of this indicator is evident in the context of the results of this benchmark);

WACC must reflect the industry’s financial structure, that is, financial leverage, and should also take into account the industry’s operational risks or beta. Since an organization’s and an industry’s beta often differ, I consider both and then perform a simulation.

Sourse:

#VALUATION – Measuring and Managing the Value of Companies
7th Edition
McKinsey & Company
Tim Koller, Marc Goedhart, David Wessels