Term · Valuation
Terminal Value
In briefThe terminal value captures the value of all cash flows that arise after the explicitly forecast time window of a DCF model. It often makes up a large part of the total DCF value, which is why the assumptions are particularly uncertain for small caps.
Definition
The terminal value represents the value of all cash flows after the explicit forecast period of a DCF model.
How it is calculated
Formula. Gordon growth: TV = FCFF_(n+1) / (WACC - g). Alternatively: sustainable metric x exit multiple.
Why it matters for small caps
The terminal value often makes up a large part of the total DCF value. For small caps, the sustainable margin, degree of maturity and long-term reinvestment are particularly uncertain.
Common misreadings
- A perpetual growth rate above the long-term plausible nominal economic growth, or an exit multiple adopted uncritically, can dominate the value.
In the process
Frequently asked
What is the terminal value?
It is the value that summarises all cash flows after the explicitly forecast period. It closes off the DCF model at the end of the forecast.
How is the terminal value calculated?
Common approaches are the Gordon growth model with a perpetual growth rate or an exit multiple on a sustainable metric. Both rely on long-term assumptions.
What danger lies in the terminal value?
A perpetual growth rate above the long-term plausible economic growth, or an exit multiple adopted without scrutiny, can dominate the total value. Small assumptions have a big effect here.
Related terms
Sources
Primary
NYU Stern – Aswath Damodaran, Valuation Resources
https://pages.stern.nyu.edu/\~adamodar/
https://pages.stern.nyu.edu/\~adamodar/
Education only, not investment advice. Ranges and thresholds are didactic orientation values, not an official standard.