Terminal Value (TV) in corporate finance is the present value of a firm's future cash flows beyond a forecast horizon, assuming perpetual growth. It's calculated using Free Cash Flow, growth rate, and discount rate, typically the firm's WACC. TV is vital for evaluating long-term financial viability in investments, acquisitions, and expansions. It's also used in project finance and can be estimated using the perpetuity growth model or the exit multiple method.
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Terminal Value is calculated using the formula TV = FCF × (1 + g) / (r - g), where FCF represents the Free Cash Flow, g is the perpetual growth rate, and r is the discount rate
Free Cash Flow (FCF)
FCF is the net amount of cash available to a company after accounting for expenses and changes in working capital
Growth rate (g)
The growth rate represents the expected annual increase in FCF indefinitely and should reflect long-term economic and industry growth prospects
Discount rate (r)
The discount rate is used to convert future cash flows into present value terms and is often derived from the company's Weighted Average Cost of Capital (WACC)
Terminal Value is crucial for evaluating the long-term financial viability of investment projects, company acquisitions, and strategic business expansions
The calculation of Terminal Value involves considering factors such as Free Cash Flow, growth rate, and discount rate
A negative Terminal Value may indicate potential financial distress or inaccuracies in the financial model, requiring a re-evaluation of assumptions and potential strategic shifts
Terminal Value is also important in project finance, where it represents the present value of a project's cash flows after the forecast period
The Exit Multiple method estimates Terminal Value by applying a multiple, such as an EBITDA multiple, to a financial metric from the last year of the forecast period
This method uses a company's EBITDA and an industry-specific exit multiple to estimate Terminal Value, providing a market-based valuation perspective
Terminal Value is a critical component in the evaluation of long-term investments, providing insight into potential returns and risks involved
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Terminal Value Formula
TV = FCF × (1 + g) / (r - g); calculates present value of future cash flows beyond forecast horizon.
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Components of TV Calculation: FCF
FCF represents Free Cash Flow in the first year post-forecast period; crucial for TV.
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Determining Discount Rate in TV
Discount rate 'r' often equals firm's WACC; used to discount future cash flows to present value.
