When using the Discounted Cash Flow (DCF) method to value a business, one of the most important pieces is the Terminal Value — and it often makes up the majority of the total valuation.
Let’s walk through exactly what terminal value is, how to calculate it, and why it matters — with examples, a calculator, and an infographic to help you visualize it.
Table of Contents
🙋♀️ What is Terminal Value?
Terminal Value (TV) estimates the value of a business beyond the forecast period — usually after 5 or 10 years — when projecting individual yearly cash flows becomes less reliable.
In simple terms:
It tells you what the business is worth after your detailed forecast ends.
There are two main ways to calculate it:
- Gordon Growth Model (Perpetuity Method)
- Exit Multiple Method
This article focuses on the more common Gordon Growth Model, used in most DCF calculations.
🧮 Terminal Value Formula
Here’s the Gordon Growth Formula for terminal value:
Terminal Value = (Final Year Cash Flow × (1 + g)) / (r − g)Where:
- g = long-term growth rate (e.g., 2%–3%)
- r = discount rate (e.g., 10%–15%)
- Final Year Cash Flow = the last cash flow in your forecast period
🌐 Example
Let’s say:
- Final year cash flow = $500,000
- Growth rate (g) = 3%
- Discount rate (r) = 12%
Then:
TV = (500,000 × 1.03) / (0.12 − 0.03)
TV = 515,000 / 0.09 = $5,722,222.22So the terminal value is approximately $5.72 million.
📘 Why Terminal Value Is So Important
- Often contributes 50%–80% of the total DCF value
- Reflects the ongoing value of a business after the detailed forecast ends
- A small change in g or r can dramatically affect the outcome — so choose them carefully!
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