288  Estimating Continuing Value 
Although the value driver formula and the cash-flow-based growth per-
petuity formula are technically equivalent, applying the growth perpetuity 
formula is tricky, and it is easy to make the common error of ignoring the in-
terdependence between free cash flow and growth. More specifically, if growth 
in the continuing-value period is forecast to be lower than the growth at the 
end of the explicit forecast period (as is normally the case), then required rein-
vestment is likely to be less, leading to higher free cash flow. If the perpetuity’s 
free cash flow is computed using cash flow from the higher-growth explicit 
forecast period, this cash flow will be too low, and the calculation will under-
estimate the continuing value. Later in this chapter, an example illustrates 
what can go wrong when using the cash flow perpetuity formula rather than 
the key value driver formula.
Because perpetuity-based formulas rely on parameters that never change, 
use a continuing-value formula only when the company has reached a steady 
state, with low revenue growth and stable operating margins. Chapters 8 and 
9 provide guidance for thinking about return on capital and long-term growth. 
In addition, when estimating the continuing-value parameters, keep in mind 
the following technical considerations:
• NOPAT. The level of NOPAT should be based on a normalized level of 
revenues, sustainable margin, and return on invested capital (ROIC). 
This is especially important in a cyclical business; revenues and oper-
ating margins should reflect the midpoint of the company’s business 
cycle, not its peak or trough.
• RONIC. The expected rate of return on new invested capital (RONIC) 
should be consistent with expected competitive conditions beyond the 
explicit forecast period. Economic theory suggests that competition will 
eventually eliminate abnormal returns, so for companies in competitive 
industries, set RONIC equal to WACC. However, for companies with 
sustainable competitive advantages, such as brands and patents, you 
might set RONIC equal to the return the company is forecast to earn 
during later years of the explicit forecast period. Chapter 8 contains data 
on the long-term returns on capital for companies in different industries.
• Growth rate. A company’s growth rate typically reverts to industry 
growth rates very quickly, and few companies can be expected to grow 
faster than the economy for long periods. The best estimate is probably 
the expected long-term rate of consumption growth for the industry’s 
products, plus inflation. Sensitivity analyses are useful for understand-
ing how the growth rate affects continuing-value estimates. Chapter 9 
provides empirical evidence on historical corporate growth rates.
• WACC. The weighted average cost of capital should incorporate a sus-
tainable capital structure and an underlying estimate of business risk 
consistent with expected industry conditions.

Continuing Value Using Economic Profit  289
Exhibit 14.2 shows how continuing value, calculated using the value driver 
formula, is affected by various combinations of growth rate and RONIC. The 
example assumes a $100 million base level of NOPAT and a 10 percent WACC. 
For RONIC near the cost of capital, there is little change in value as the growth 
changes. This is because the company is taking on projects whose net present 
value is close to zero. At an expected RONIC of 14 percent, however, chang-
ing the growth rate from 6 percent to 8 percent increases the continuing value 
by 50 percent, from about $1.4 billion to about $2.1 billion. The higher the 
RONIC, the more sensitive the continuing value is to changing growth rates.
Two-Stage Continuing-Value Models
For high-growth companies or companies undergoing long-term structural 
changes, we recommend extending the explicit forecast period until the com-
pany reaches a steady state. If the resulting model is too cumbersome, use a 
multistage continuing value that aggregates multiple years into a single for-
mula. In a two-stage model, the continuing value is split into a growth annuity 
followed by a growth perpetuity. This allows for distinct returns on capital 
and growth rates for different stages of the company’s life, without the burden 
of year-by-year forecasts. We provide two-stage continuing-value formulas 
for discounted cash flow and economic-profit models in Appendix I.
Continuing Value Using Economic Profit
To estimate continuing value in an economic-profit valuation, we again rely 
on perpetuity-based formulas. With the economic-profit approach, however, 
the continuing value does not equal the value of the company following the 
EXHIBIT 14.2  Impact of Continuing-Value Assumptions
WACC = 10%; NOPAT = $100 million
0
1,000
10
12
14
16
Return on new invested capital, %
Continuing value, $ million
18
Growth = 8%
Growth = 6%
Growth = 4%
20
2,000
3,000