Calculating Terminal Cash Flow
## How to Calculate Terminal Cash Flow
### Introduction
Terminal value (TV) is the estimated value of an asset, business, or project beyond the forecasted period when future cash flows can be estimated. TV assumes a business will grow at a set growth rate forever after the forecast period. TV often comprises a large percentage of the total assessed value.
### Methods of Calculating Terminal Value
There are two commonly used methods to calculate terminal value:
* **Perpetual Growth (Gordon Growth Model):**
* This method assumes that the business will generate cash flows at a constant rate forever.
* The formula to calculate terminal value using this method is:
“`
Terminal Value = Final Year Cash Flow / (Discount Rate – Perpetuity Growth Rate)
“`
* The perpetuity growth rate is the constant rate at which the company is expected to grow forever. It usually starts at the end of the last forecasted cash flow period and is usually in line with the long-term inflation rate but not higher than the historical GDP growth rate.
* **Exit Multiple Method:**
* This method assumes that the business will be sold for a multiple of some market metric.
* The formula to calculate terminal value using this method is:
“`
Terminal Value = Most Recent Metric (e.g., sales, EBITDA) x Exit Multiple
“`
* The exit multiple is a factor that is common for recently acquired and similar firms. It is usually an average of recent exit multiples for other transactions.
### Conclusion
TV is a crucial part of DCF analysis as it accounts for a significant portion of the total value of a business. It is important to carefully consider the assumptions made when calculating TV, as they can significantly impact a business’s overall valuation.
### Sources
* [How to Calculate Terminal Value](https://wealthyeducation.com/how-to-calculate-terminal-value/)
* [Terminal Value (TV) Definition and How to Find The Value (With Formula)](https://www.investopedia.com/terms/t/terminalvalue.asp)
* [Terminal Value: Formula, Calculation, Methods and Examples](https://navi.com/blog/terminal-value/)
FAQs
What is terminal cash flow?
Terminal cash flow is the estimated value of an asset, business, or project beyond the forecasted period when future cash flows can be estimated. It assumes a business will grow at a set growth rate forever after the forecast period.
Why is terminal cash flow important?
Terminal cash flow is important because it accounts for a significant portion of the total assessed value of a business or project. It is used in discounted cash flow (DCF) analysis to determine the overall value of an investment.
What are the methods for calculating terminal cash flow?
The two most common methods for calculating terminal cash flow are the perpetual growth (Gordon Growth Model) and the exit multiple method.
What is the perpetual growth (Gordon Growth Model) method?
The perpetual growth method assumes that the business will generate cash flows at a constant rate forever. The formula to calculate terminal value using this method is: