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Terminal value

Valuing everything after the forecast horizon, and why it dominates.

A business does not stop after ten years, so the forecast ends with a lump sum for all later cash flows. That lump is usually 60% to 80% of the total value, which makes it the most important and most abused number in a DCF.

Perpetuity growth (default)

Assume the final-year cash flow grows at a constant rate gg forever. A growing perpetuity discounted at WACC has a closed form, the Gordon growth formula:

TVn=FCFFn+1WACC−g\text{TV}_n = \frac{\text{FCFF}_{n+1}}{\text{WACC} - g}

The subtle part is FCFFn+1\text{FCFF}_{n+1}. Growth in perpetuity still requires reinvestment, and the amount depends on the return the company earns on new capital. If terminal return on invested capital is ROICT\text{ROIC}_T, the reinvestment rate needed to sustain gg is g/ROICTg / \text{ROIC}_T:

FCFFn+1=NOPATn (1+g)(1−gROICT)\text{FCFF}_{n+1} = \text{NOPAT}_n\,(1+g)\left(1 - \frac{g}{\text{ROIC}_T}\right)

This is the growth-equals-reinvestment-times-return identity. Ignoring it lets a model assume free growth. When terminal ROIC is left blank the engine sets it equal to WACC, which means no excess returns in perpetuity: competition has eroded the moat, and growth adds no value. Setting ROIC above WACC asserts a permanent competitive advantage and is flagged.

Two constraints keep the formula honest. Terminal growth must not exceed the risk-free rate, because nothing outgrows the economy forever. And WACC minus gg is clamped to at least 0.5%, since the formula explodes as the two converge.

Exit multiple

TVn=Multiple×EBITDAn\text{TV}_n = \text{Multiple} \times \text{EBITDA}_n

Apply a market EV/EBITDA multiple to the final year. This borrows the market's pricing rather than reasoning from fundamentals, and quietly imports whatever the market believes today about growth and risk. Useful as a cross-check, weaker as a primary method.

Share of value in the terminal

The result reports the fraction of enterprise value that sits in the terminal. Above 90% with negative explicit cash flows means the valuation rests entirely on the far future.

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