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What is Terminal Value? How to Calculate it?

What is Terminal Value? How to Calculate it?

You must have come across this article looking for detailed information on the term ‘Terminal Value.’ You are on the right page. Terminal value is one of the important metrics whenever there is a need to know future cash flows activity. This term is also referred to as horizontal value or continuing value.

Terminal value is all about forecasting present business cash flows at the stable rate of growth assumption. It is often used as a broad range of metrics. But, most probably this term or value is used for calculating discounted cash flows (DCF).

Terminal Value

Thus, for everyone who wants to calculate DCF, the Terminal value is vital for them. Let’s have a look at the complete information below.

What is Terminal Value?

We have mentioned this earlier. Terminal value is all about forecasting present business cash flows at the stable rate of growth assumption. You can assume future cash growth by looking at the present growth of the business. Moreover, it is often used for calculating discounted cash flows.

But, do we know the main question? The primary question is Why is Terminal Value significant?

It does become more challenging to forecast the current value into the future attempt. However, it is effective for giving value to the assets and businesses. The reason discounted cash flows becomes an essential need to calculate the total value of a project or business.

How to Calculate Terminal Value?

We now know about the definition. For instance, two methods are generally used for calculating Terminal value. Let’s have a look.

Terminal Multiple Method – 1

Terminal Multiple Method assumes a finite window of operations. The Terminal Value is needed for reflecting the correct value of the business in time. In most cases, this method assumes that the business will get sold at the project end.

To complete this calculation, you need to multiply the Terminal Value to EBITDA. This could be as follows:

Terminal Value = Terminal Multiple from Last 12 Months x Projected Statistic (EBITDA)

Perpetuity Growth Model – 2

Unlike the terminal multiple methods, the Perpetuity growth model will assume the present situation of the business cash flows and expects steady growth in future.

For calculation, you need to divide the last cash flow by the difference between the terminal growth and the discounted rate. This could be as follows:

Terminal Value = (Free Cash Flow x (1+g)) / (WACC – g)

What are the disadvantages of using Terminal Value?

To be an instance, a couple of limitations are already initiated with the use of Terminal Value as a forecasting formula. For the Terminal Multiple Method, it is essential to remember the dynamic changes over time for the correct calculation. This could be one of the hectic disadvantages of using this formula.

In the perpetuity growth model, it is tough to assume the correct rate of growth as the results are not always the same. Therefore, it could be again a disadvantage.

However, the limitations or disadvantages does not mean that Terminal Value is not an essential or meaningful metric. It is essential but only when it comes to using it at the right place and at the right time.

Conclusion

Here we go. We already know about the definition of the term ‘Terminal.’ Still, Terminal value is all about forecasting present business cash flows at the stable rate of growth assumption. 

For instance, it is one of the essential metrics used for calculating the future forecast of business cash flows. We have added this article to explain all of the stuff related to this term. We hope it helps.

 

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