Transversality and the Stochastic Nature of Cash Flows
19 Pages Posted: 1 Jan 2014
Date Written: December 31, 2013
We show that a transversality condition is necessary when it comes to valuing a company with an infinite lifespan. Without transversality the firm value cannot be uniquely determined. Also, an assumption on a lower bound of cash flows is necessary to achieve the desired result. We discuss four different stochastic cash flow processes and analyze to what extent the processes associated with these enterprise values satisfy the transversality condition.
Keywords: transversality, discounted cash flow, mean reversion, autoregression
JEL Classification: G12
Suggested Citation: Suggested Citation