Estimating Constant Growth Terminal Values with Inflation

Abstract

In most corporate valuations the continuing, or terminal, value accounts for a majority of the total estimated value, but it is rarely given the attention it deserves. An exception is the work of Bradley and Jarrell (2008), who examine the impact of inflation on the constant growth model most commonly used to estimate the terminal value. They claim that standard constant growth models error by not properly accounting for inflation. Here we extend the work of Bradley and Jarrell and reconcile it with the traditional models. Our conclusion is that standard models work, but only if the terms are defined and applied consistently. It turns out that those consistent definitions are complicated by the interaction of inflation with accounting conventions. In particular, it is necessary to distinguish depreciable assets from non-depreciable assets and to contrast both with unrecorded intangible assets.