Terminal Value
Definition
Terminal value is the estimated value of a business, project, or asset beyond a forecast period, representing the present value of all future cash flows after the projection period.
Explanation
Terminal value is a critical component of DCF valuation, often accounting for 60-80% of the total valuation. It is calculated using either the perpetuity growth method (assuming steady growth forever) or the exit multiple method (applying a valuation multiple to a terminal metric).
Because terminal value represents such a large portion of total value, small changes in assumptions can significantly impact the valuation. Analysts should use reasonable growth rates and test sensitivity to key assumptions.
Example
A DCF valuation projects cash flows for 5 years, then assumes a perpetual growth rate of 3% to calculate the terminal value. If terminal value is $10 million and the total valuation is $13 million, terminal value represents 77% of the value.