Terminal Value
Terminal Value is a financial metric used to estimate the value of a business or an investment at the end of a forecast period, extending into perpetuity. It is a critical component in discounted Cash Flow (DCF) analysis, reflecting the anticipated Cash Flows beyond the projection period. Terminal value can be calculated using either the Gordon Growth Model or the Exit Multiple Method.
Gordon Growth Model
This method assumes that Cash Flows will continue to grow at a stable rate indefinitely. The formula is:
Terminal Value = (Final Year Cash Flow × (1 + g)) / (r – g)
Where g is the perpetual growth rate and r is the Discount Rate.
Example:
If the final year Cash Flow is $1,000,000, the growth rate is 3%, and the Discount Rate is 8%, the terminal value would be:
Terminal Value = ($1,000,000 × (1 + 0.03)) / (0.08 – 0.03) = $21,000,000
Exit Multiple Method
This method estimates the terminal value based on a multiple of financial metrics such as EBITDA, EBIT, or Revenue. The formula is:
Terminal Value = Financial Metric × Chosen Multiple
Example:
If the projected EBITDA in the final year is $2,000,000 and the chosen exit multiple is 5x, the terminal value would be:
Terminal Value = $2,000,000 × 5 = $10,000,000
Cases:
Terminal value is particularly relevant in industries with stable Cash Flows or where companies have significant market presence, such as:
- Consumer Goods: Established brands with predictable demand.
- Utilities: Regulated industries with stable earnings.
- Technology: Mature firms with consistent Cash Flows.