Terminal Value Calculator

What the terminal value calculator does

The terminal value calculator estimates what a business or asset is worth beyond the end of an explicit cash-flow forecast. In a discounted cash flow (DCF) valuation, analysts project cash flows in detail for a handful of years and then need one number for everything afterwards. That number is the terminal value, and in most models it accounts for most of the total valuation.

The tool uses the Gordon growth method, also called the perpetuity growth model. You provide the cash flow in the final forecast year, the rate at which it is expected to grow forever, and the discount rate, and get the terminal value, the next year's cash flow, and the spread between the discount and growth rates.

How terminal value works

A DCF splits a company's life into the explicit forecast period, typically five to ten years with each year modelled directly, and everything beyond that horizon. The terminal value collapses that infinite tail into one figure, calculated as of the last forecast year.

The perpetuity growth model assumes that after the forecast, cash flow grows at a constant rate forever. Such a stream has a finite present value as long as the discount rate is larger than the growth rate: the return investors demand must exceed the pace at which the business grows in perpetuity.

Money arriving far in the future is worth very little today, so although the stream never ends, each successive payment is discounted more heavily and the total converges. A narrow gap between the discount rate and the growth rate gives a large, highly sensitive value; a wide gap gives a smaller, steadier one.

The formula

TV = CF_n × (1 + g) ÷ (r − g)

CF_n is the cash flow in the final forecast year, g is the perpetual growth rate, and r is the discount rate. The calculator first grows the final cash flow by one year, CF_n × (1 + g), because the perpetuity starts the year after the forecast ends, and then divides by the difference between the discount and growth rates.

If the growth rate is equal to or greater than the discount rate, the formula breaks down and the calculator returns zero to show that the assumptions are not valid. A business cannot grow faster than its discount rate forever without being worth an infinite amount.

The three assumptions

• Final-year cash flow is the free cash flow in the last year of your explicit forecast. Everything scales from it, so use a normal, sustainable level, not an unusually high or low year.
• The perpetual growth rate is how fast cash flow grows forever after the forecast. Keep it modest, usually no higher than long-run inflation or the expected growth of the wider economy; small changes move the answer a lot.
• The discount rate, often the weighted average cost of capital (WACC), is the return investors require. A higher rate lowers the terminal value because future cash is worth less today.

Why the spread matters

Because the formula divides by the spread between the discount rate and the growth rate, a small change in either can swing the valuation sharply. Raising the growth rate from two to three percent, with the discount rate at ten percent, shrinks the denominator from eight points to seven and raises the terminal value by about 15%.

Careful analysts therefore test the terminal value across a range of growth and discount assumptions. When the spread is narrow, reasonable-looking inputs can produce very different valuations, so keep the perpetual growth rate conservative and check how the answer behaves as the spread changes.

Common uses

The calculator supplies the tail value that the explicit forecast of a DCF cannot capture. It shows how much of a valuation rests on the growth and discount assumptions. It also gives a quick cross-check: if a valuation multiple implies a very different figure from the perpetuity view, investigate before relying on either.

A worked example

A forecast ends with 100,000 in cash flow, expected to grow two percent forever, discounted at ten percent. Next year's cash flow is 102,000, and dividing by the eight-point spread gives a terminal value of 1,275,000. That figure sits at the end of the forecast period, so in a full DCF you would discount it back to the present before adding it to the value of the explicit cash flows.

About This Terminal Value Calculator

Use this terminal value calculator to get an instant estimate based on the figures you enter. Adjust the inputs above to match your situation, or browse all our calculators to plan your next step.