186  Frameworks for Valuation
ROICs without goodwill both above 20 percent. A good analysis will assess 
many years—even decades—of past performance. While analysis from long 
ago may be outdated, understanding how the company performs in differ-
ent phases of the economic cycle will better inform your forecasts. For an in-
depth discussion of financial analysis using reorganized financial statements, 
see Chapter 12.
Projecting Revenue Growth, ROIC, and Free Cash Flow  Based on in-
sights from your historical analysis, as well as forecasts of economic and in-
dustry trends, create a set of integrated financial statements going forward. 
In Exhibits 10.5 and 10.6, we present line-by-line forecasts of the income 
statement, statement of shareholders’ equity, and balance sheet. The three 
statements should be integrated in that net income should flow through the 
statement of equity, which should match the corresponding account in the 
balance sheet. Use excess cash, debt, dividends, or a combination thereof to 
ensure that the balance sheet balances. Chapter 13 provides details on the 
forecasting process.
When building the forecast model, use judgment on how much detail to 
forecast at various points. Over the short run (the first few years), forecast 
each financial-statement line item, such as gross margin, selling expenses, 
accounts receivable, and inventory. This will allow you to incorporate vis-
ible trends in individual line items. Moving further out, individual line items 
become difficult to project, and a high level of detail can obscure the criti-
cal value drivers. Therefore, over the medium horizon (5 to 15 years), focus 
on the company’s key value drivers, such as operating margin, the operating 
tax rate, and capital efficiency. At some point, projecting even key drivers on 
a year-by-year basis becomes impractical. To value cash flows beyond this 
point, use a continuing-value formula, often called the terminal value. Choos-
ing an appropriate point of transition depends on the company and how it is 
changing over time. A company undergoing significant change may require a 
long, detailed window, whereas a stable, mature company may require very 
little detail in your forecasts.
Next, use the reorganized financial statements to calculate free cash flow. 
Exhibit 10.10 presents the free cash flow for GlobalCo. Defined in a manner 
consistent with ROIC, free cash flow is derived directly from NOPAT and 
the change in invested capital. Unlike the accounting statement of cash flows 
(provided in the company’s annual report), free cash flow is independent of 
nonoperating items and capital structure.
Estimating Continuing Value  At the point where predicting the individual 
key value drivers on a year-by-year basis becomes impractical, do not vary 
the individual drivers over time. Instead, use a perpetuity-based continuing 
value, such that:

Enterprise Discounted Cash Flow Model  187
EXHIBIT 10.10  GlobalCo: Projected Free Cash Flow
$ million
Year 1
Year 2
Year 3
NOPAT
60.0
69.0
72.5
Depreciation
20.0
25.0
28.8
Gross cash flow
80.0
94.0
101.2
 
Decrease (increase) in operating working capital
(12.0)
(9.0)
(3.4)
Capital expenditures, net of disposals
(70.0)
(62.5)
(43.1)
Free cash flow
(2.0)
22.5
54.6
Reconciliation of free cash flow
Interest expense
10.0
10.8
11.4
Interest tax shield
(2.0)
(2.2)
(2.3)
Decrease (Increase) in short-term debt
0.0
(15.4)
(8.6)
Decrease (Increase) in long-term debt
(20.0)
–
–
Flows to (from) debt holders
(12.0)
(6.8)
0.5
Cash dividends
10.0
14.3
24.1
Repurchased (issued) shares
–
15.0
30.0
Flows to (from) equity holders
10.0
29.3
54.1
Free cash flow
(2.0)
22.5
54.6
Value of Operations
Present Value of Free Cash Flow
during Explicit
=
Forecast Period
Present Value of Free Cash Flow
after Explicit For
+
ecast Period
Although many continuing-value models exist, we prefer the key value 
driver formula presented in Chapter 3. The key value driver formula is su-
perior to alternative methodologies because it is based on cash flow and it 
links cash flow directly to growth and ROIC. The key value driver formula is 
expressed as follows:
Continuing Value
NOPAT
RONIC
WACC
t
t
g
g
=
−




−
+1 1
The formula requires a forecast of NOPAT in the year following the explicit 
forecast period, the long-run forecast for return on new invested capital 
(RONIC) purchased during the continuing value period, the WACC, and 
long-run growth (g) in NOPAT.
Exhibit 10.11 presents an estimate for GlobalCo’s continuing value. Based 
on a final-year estimate of NOPAT from Exhibit 10.7 of $74.0 million, RONIC 
excluding goodwill from Exhibit 10.9 of 19.8 percent, and a long-term growth