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Terminal Value (TV) is a pivotal element in Discounted Cash Flow (DCF) analysis, used to estimate a company's present value by projecting future cash flows. The text delves into the calculation of TV using the Gordon Growth Model and other methods like the Exit Multiple Method, as well as advanced techniques such as the Excess Return and NOPLAT methods. It also discusses the influences on TV estimation, including the forecast period, discount rate, perpetual growth rate, and the stability of cash flows.
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Terminal Value is a crucial component in the Discounted Cash Flow (DCF) analysis, used to estimate the present value of a company
Primary Inputs
The calculation of Terminal Value in a DCF model involves two primary inputs: projected free cash flow and a discount rate
Gordon Growth Model
The Terminal Value is typically calculated using the Gordon Growth Model, which assumes a perpetual growth rate for future cash flows
The estimation of Terminal Value is influenced by factors such as the forecast period, discount rate, perpetual growth rate, and stability of cash flows
The Terminal Value is converted to present value by discounting it using the chosen discount rate
The accuracy of the present value calculation is highly dependent on the chosen discount rate, which reflects the riskiness of the company's future cash flows
The present value of Terminal Value is calculated using the formula: Present Value of TV = TV / (1 + r)^n, where r is the discount rate and n is the number of years from the valuation date to the end of the forecast period
The Perpetuity Growth Model assumes that the company's free cash flow will continue to grow at a constant rate indefinitely
The Exit Multiple Method involves applying an industry-specific multiple to a financial metric projected for the company at the end of the forecast period
Excess Return Method
The Excess Return method calculates the economic profit by subtracting the cost of capital from the return on invested capital
Net Operating Profit Less Adjusted Taxes (NOPLAT) Method
The NOPLAT method discounts the company's projected NOPLAT at the end of the forecast period to present value, providing a more straightforward approach compared to the Excess Return method
The choice between methods for calculating Terminal Value depends on the company's industry, growth prospects, and risk factors
The Perpetuity Growth Model is often suitable for stable companies, while the Exit Multiple Method is advantageous for comparative analysis within an industry. The Excess Return and NOPLAT methods are more appropriate for companies with high growth potential or consistent reinvestment rates
00
The ______ Value is used to represent the present value of a company's cash flows beyond a detailed forecast period, typically ______ to ______ years.
Terminal
five
ten
01
Inputs for Terminal Value calculation
Projected FCF at end of forecast (FCF_n+1) and risk-adjusted discount rate (r).
02
Gordon Growth Model assumption
Perpetual growth rate (g) for future cash flows.
