Nothing Lasts Forever, Perpetuities and Terminal Values

I've done a review previously of geometric sequences and series, as a prelude for explaining perpetuities (the DDM is a form of growing perpetuity to determine a price in today's dollars).

I'll probably be doing a lot of valuation modeling at my equities research position over the next two months, so I though I would posts some thoughts on the techniques and methods regarding the basics of modeling (with my posts becoming more sophisticated as I become more sophisticated).

Technically speaking, a stock is a form of perpetuity (with the incremental value as the earnings per share). Most models assume that the company will exist forever and discount the earnings flows to come up with a price for the asset. In the current climate of bankruptcies, anyone would be naive to believe this is the case any more (if it ever was).

However, in private equity this isn't always the case (in fact it often isn't), as firms will buy undervalued companies (or companies in which they plan on making management or strategy changes) in an attempt to flip the company (buy it, fix it up and sell it) for higher exit multiples.

In modeling, there are different reasons for creating terminal values. It simplifies the valuation process (rather than calculating 10 more years of earnings growth estimates, you can boil it down to one number to represent the value of the earnings of the remaining years) or if you plan on selling the company, you can model a target exit price.