Terminal Value
The estimated value of a business beyond the explicit forecast period in a discounted cash flow model.
What is Terminal Value?
Terminal value (TV) represents the present value of all cash flows expected after the end of a DCF model's explicit forecast period, which typically spans 5–10 years. It usually accounts for 60–80% of total enterprise value in DCF analyses, making it the most influential component. The two main methods are: (1) the Gordon Growth Model: TV = Final Year FCF × (1 + g) / (WACC − g), where g is the perpetuity growth rate; and (2) the Exit Multiple approach: TV = Final Year EBITDA × Exit Multiple. The perpetuity growth model assumes cash flows grow at a constant rate forever; the exit multiple approach uses a market-derived valuation ratio to estimate terminal value. Both methods require careful assumption-setting because small changes in inputs produce large swings in terminal value.
Example
An analyst valuing a software company projects $100 million in free cash flow in year 5, growing at 3% per year in perpetuity (the terminal growth rate), with a WACC of 8%. Terminal value = $100M × 1.03 / (0.08 − 0.03) = $103M / 0.05 = $2.06 billion. Discounted back 5 years at 8%, the present value of terminal value is $1.40 billion — representing about 75% of the total DCF enterprise value. Changing the growth rate from 3% to 4% increases terminal value to $2.47 billion, a 20% change on one assumption.
Source: Damodaran Online — DCF Valuation