Misunderstandings about Continuing Value  291
Misunderstandings about Continuing Value
Properly applied, continuing value can simplify your valuation while incor-
porating robust economic principles. In practice, however, proper application 
often requires correcting three common misunderstandings about continuing 
value. The first is the perception that the length of the explicit forecast affects the 
company’s value. As we show in this section, only the split of value is changing, 
not the total value. Second, people incorrectly believe that value creation stops 
at the end of the explicit forecast period, when return on new invested capital is 
set equal to WACC in the continuing-value formula. As we demonstrate, since 
returns from existing capital carry into the continuing-value period, aggregate 
ROIC will only gradually approach the cost of capital. Finally, some invest-
ment professionals incorrectly infer that a large continuing value relative to 
the company’s total value means that value creation occurs primarily after the 
explicit forecast period. This makes them uneasy about using enterprise DCF. 
In this section, we show why these concerns are not necessarily justified and 
why continuing value is more robust than often perceived.
Why Forecast Length Doesn’t Affect a Company’s Value
While the length of the explicit forecast period you choose is important, it does 
not affect the value of the company; it affects only the distribution of the com-
pany’s value between the explicit forecast period and the years that follow. In 
Exhibit 14.3, the value of the company is $893 million, regardless of how long 
the forecast period is. With a forecast horizon of five years, the continuing 
value accounts for 79 percent of total value. With an eight-year horizon, the 
continuing value accounts for only 67 percent of total value. As the explicit 
forecast horizon grows longer, value shifts from the continuing value to the 
explicit forecast period, but the total value always remains the same.
EXHIBIT 14.3  Comparison of Total-Value Estimates Using Different Forecast Horizons
%
Continuing value
100% =
Modeling assumptions
 
Years 1–5 
Years 6+
Growth 
9 
6
RONIC 
16 
12
WACC 
(12) 
(12)
Spread 
4 
0
$893
$893
$893
$893
$893
79
67
60
46
35
21
33
40
54
65
5
8
10
Length of explicit forecast period, years
15
20
Value of explicit 
free cash flow

292  Estimating Continuing Value 
To see how the value shift works, compare Exhibits 14.4 and 14.5. The former 
details the calculations for the valuation model using a five-year explicit fore-
cast period, whereas the latter repeats the analysis with an eight-year period.
In Exhibit 14.4, NOPAT starts at $100 million. During the first five years, 
NOPAT grows at 9 percent per year. Following year 5, NOPAT growth slows 
to 6 percent. Using the definition of free cash flow derived in Chapter 10, 
EXHIBIT 14.4  Valuation Using Five-Year Explicit Forecast Period
$ million
Year 1
Year 2
Year 3
Year 4
Year 5
Base 
for CV
NOPAT
100.0
109.0
118.8
129.5
141.2
149.6
Depreciation
20.0
21.8
23.8
25.9
28.2
Gross cash flow
120.0
130.8
142.6
155.4
169.4
Gross investment
(76.3)
(83.1)
(90.6)
(98.7)
(107.6)
Free cash flow (FCF)
43.8
47.7
52.0
56.7
61.8
× Discount factor
0.893
0.797
0.712
0.636
0.567
Present value of FCF
39.1
38.0
37.0
36.0
35.0
Present value of FCF1–5
185.1
Calculation of continuing value (CV)
Continuing value
707.5
CV
CV
WACC
0
5
5
5
1
1 12
707 5
=
+
=
=
(
)
( .
)
$
.
CV
NOPAT
g
RONIC
WACC
CV
5
1
1
=
−




−
=
−
g
1246 9
$ ,
.
(
)
=
$1,246.9
0.06
0.12
$149.6
0.12 – 0.06
Total value
892.6
EXHIBIT 14.5 Valuation Using Eight-Year Explicit Forecast Period
$ million
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Year 7
Year 8
Base 
for CV
NOPAT
100.0
109.0
118.8
129.5
141.2
149.6
158.6
168.1
178.2
Depreciation
20.0
21.8
23.8
25.9
28.2
29.9
31.7
33.6
Gross cash flow
120.0
130.8
142.6
155.4
169.4
179.6
190.3
201.7
Gross investment
(76.3)
(83.1)
(90.6)
(98.7)
(107.6)
(104.7)
(111.0)
(117.7)
Free cash flow (FCF)
43.8
47.7
52.0
56.7
61.8
74.8
79.3
84.1
× Discount factor
0.893
0.797
0.712
0.636
0.567
0.507
0.452
0.404
Present value of FCF
39.1
38.0
37.0
36.0
35.0
37.9
35.9
34.0
Present value of FCF1–8
292.9
Calculation of continuing value (CV)
Continuing value
599.8
CV
NOPAT
g
RONIC
WACC
CV
8
1
=
−




−
=
g
CV
CV
WACC
0
8
8
8
1
1 12
=
+
=
=
(
)
( .
)
1 −
0.12 – 0.06
$1,485.1
(
)
=
$599.8
$1,485.1
0.06
0.12
$178.2
Total value
892.6