Liquidating net working capital
The terminal value of the common stock is the total levered terminal value less the terminal value of the debt, less the terminal value of the preferred stock (adding in the amount from any warrants that are exercised at their exercise price), plus the cash gained from the exercise of any common and preferred warrants.
You are selling your business, and all of your ducks are in a row.
For this reason, the terminal value calculation often is critical in performing a valuation.
The terminal value can be calculated either based on the value if liquidated or based on the value of the firm as an ongoing concern.
The terminal value of a piece of manufacturing equipment at the end of its useful life is its salvage value, typically less than 10% of the present value.
In contrast, the terminal value associated with a business often is more than 50% of the total present value.
The levered terminal value is calculated using the weighted average cost of capital (WACC) as the discount rate.
The terminal value of debt or preferred stock is simply the projected book value of the debt or preferred stock in the year that the terminal value is being calculated.
The terminal value can represent a large portion of the valuation.It is as essential to running a business as the employees and physical assets.While some businesses can operate on negative working capital (current liabilities greater than current assets), such as subscription-based media companies or other firms that require large up-front payments from their customers, most firms have positive working capital requirements that grow along with the business.From the buyer perspective, working capital has two important implications, one relating to the acquisition purchase price and the other relating to the ongoing cash flows of the business. Working capital is a real investment in the business and, like the important machinery or computer hardware, cannot be fully liquidated without a serious negative impact on the business.Also, working capital accounts tend to grow as the company’s revenues increase.
Buyers often require that a minimal amount of cash be left in the business so that short term needs can be met without drawing on an interest-bearing revolving facility or potentially delaying vendor payments or payroll.