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Finance · level 2

Terminal value

Grow the final forecast year once, then divide by (WACC − g). Convert the result into an implied multiple immediately — that is how you tell whether it is credible.

Theory: Valuation

Worked example: Year-5 FCF $180M, WACC 8%, terminal growth 2.5%. Terminal value at year 5?

FCF₆$184.5M
WACC − g5.5%
terminal value$3.35B

Step by step

  1. 1

    Grow one more year

    $180M × 1.02 = $184.5M

  2. 2

    Gordon

    / (8% − 2.5%) = $3.35B

  3. 3

    Implied exit multiple

    18.2× FCF

  4. 4

    Watch out

    Terminal value routinely carries 60–80% of a DCF; sanity-check it against a trading multiple.

Year-5 FCF $180M, WACC 8%, terminal growth 2.5%. Terminal value at year 5? = 3,354,545,455

The theory behind it

Intuition

Terminal value is usually 60–80% of a DCF, so the perpetuity growth rate deserves more scrutiny than the explicit forecast.

Common pitfalls

  • ×Perpetuity growth above long-run GDP growth.
  • ×Discounting terminal value one period too few.

In the interview

The number to stress-test when a valuation looks too good.