What is Terminal Value in DCF?

Terminal Value (TV) is a component of a Discounted Cash Flow (DCF) valuation that represents the estimated value of a business for all the years beyond the explicit forecast period (typically 5-10 years). Since it's impossible to forecast cash flows forever, TV is used to capture the value of the company into perpetuity.

For Startups: In a startup valuation, the Terminal Value often accounts for a very large portion (sometimes over 75%) of the total company value. This is because most of a startup's value is expected to be realized in the long term, after it has achieved scale.

For Valuation: There are two common methods to calculate TV: the Gordon Growth Model (Perpetuity Growth Method) and the Exit Multiple Method.

Calculation (Gordon Growth): TV = (Final Year's Free Cash Flow * (1 + Perpetual Growth Rate)) / (Discount Rate - Perpetual Growth Rate)

Example: A model projects cash flows for 5 years and then calculates a Terminal Value to represent the value of the business from year 6 onwards.