The “Mission Impossible” of a Steady State, Value-Neutral Investments, and Value Maximization in Terminal Value Calculations

Abstract Assumptions about growth and profitability in terminal values significantly influence corporate valuations but are inherently uncertain and challenging to predict. To mitigate potential manipulation, theory and valuation practice often recommend two premises: 1) the firm operates in a steady state, justifying a perpetual constant growth rate, and 2) net investments in the terminal value calculation are value-neutral, yielding returns equal to the firm’s cost of capital. This paper evaluates the consistency of these assumptions with a value-maximizing investment policy. By modeling the firm as a series of investment projects under a constant investment technology with decreasing returns to scale, we find that value-maximizing investment levels remain steady over time, leading to zero growth. Achieving a steady state with positive nominal growth requires continuous productivity improvements in the investment technology. When such improvements occur, optimal investment scales can increase at a constant rate, necessitating value-enhancing net investments. In this scenario, value-neutral net investments misalign with the optimal strategy, resulting in suboptimal decisions and reduced terminal value. Our findings indicate that, under standard investment technology assumptions, positive nominal growth, value-neutral net investments, and value-maximizing behavior cannot coexist in a steady state. Consequently, standard setters and practitioners must choose between adhering to investment theory by abandoning the value-neutrality assumption—accepting increased ambiguity and uncertainty in growth projections—or retaining the value-neutrality assumption at the expense of theoretical soundness in corporate valuation.