A Life Cycle Model of Firm Value

Business valuation must rely on assumptions about the time dynamics of firms' future value flows. By separating the standard net cash flow variable into expenditures and revenues and replacing the commonly assumed constant future growth rate with a life cycle trajectory, one obtains a flexible, non-monotonic description of a firm's evolution through time at the level of its individual investments and their aggregation into intrinsic enterprise value. A parsimonious set of assumptions permits an empirical estimation that requires no inputs other than financial accounting data and that delivers estimates of intrinsic firm value and the cost of capital that align well with observed market values. Empirical tests support the model's analytical predictions about the time-series behavior of various growth rates and profitability ratios.