Terminal Value

Analysts usually forecast a company's cash flows in detail for five to ten years. Beyond that, detailed forecasting becomes unreliable, but the business is expected to keep operating. Terminal value is a single figure that represents all those later years.

There are two common ways to calculate it. The perpetual growth method assumes cash flows grow at a steady rate forever. If cash flow in the first year after the forecast is 10 million, the discount rate is 9% and long-term growth is 2%, the terminal value is 10 million divided by 7%, about 143 million. The exit multiple method instead applies a market multiple, such as eight times EBITDA, to the final year's figures.

The terminal value is then discounted back to today and added to the value of the forecast years.

Terminal value often makes up more than half of a company's estimated value in a discounted cash flow model. Because it rests on assumptions about the distant future, small changes in growth or discount rate can change the result significantly.