Terminal Value for Firms with Multiple Business Units and Heterogeneous Return on Investment

To support managers’ and investors’ decisions, corporate valuation models should be able to render firms’ strategic choices with sufficient accuracy. In particular, they should reflect information on firms’ long-term investments in its portfolio of businesses: Firms (re-)balance their activities by diverting cash flows from some business units to fund investments in other units. We develop a value driver model of terminal value for a firm with two business units, which differ in their return on invested capital and net investment rates. We consider cross-unit investments and show their implications for firm value and for the long-term development of the key accounting variables. Moreover, we study under which conditions business unit strategy can be reconciled with popular firm strategies such as constant payout and constant growth strategies. We use a simulation analysis to illustrate the practical relevance of our results. We further highlight under which conditions an accurate depiction of business unit strategy is particularly useful to reduce valuation errors.