Discounting and value
Terminal value
Capture the value beyond the forecast period — usually most of a DCF.
18 minintermediateMembers
Learning objectives
- Calculate a Gordon growth terminal value
- Discount the terminal value to today
- Judge whether a terminal value assumption is reasonable
- Derive a steady-state cash flow consistent with the growth rate
A forecast covers a few years, but a business can go on much longer. The terminal value (TV) summarises all cash flows after the forecast in one number, valued at the end of the final forecast year (year n).
The Gordon growth method assumes free cash flow grows at a constant rate g forever. The rate must be below WACC, and in practice no higher than long-run nominal economic growth: no company can outgrow the economy forever.
TVₙ = FCFₙ₊₁ ÷ (WACC − g) = FCFₙ × (1 + g) ÷ (WACC − g)
- FCFₙ₊₁
- the first cash flow after the forecast — a normalized, steady-state year
- g
- perpetual growth rate of FCF
- PV of TV
- TVₙ ÷ (1 + WACC)ⁿ — discounted n years, because TVₙ is already a year-n value
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