What is the final value?

Definition of Terminal Value

Terminal value is the value of an investment or business at the end of a projected period. It is often estimated in a discounted cash flow model as a way to account for the company’s value at the end of the expected investment period or the time when the valuation can be measured more accurately.

How to Calculate Terminal Value

There are three main methods to estimate terminal value: liquidation value, multiple approaches, and stable growth.

Liquidation Value

Liquidation value assumes that the company will not operate indefinitely but will close and be sold at some point in the future, and the estimated net asset value for sale will be the terminal value. There are two methods to estimate liquidation value. Both methods focus on the company’s assets.

Multiple Approaches

The multiple approaches to calculating terminal value are based on the assumption that the company can be sold at a multiple of some key value measure such as revenue or net income, which is a measurable metric from comparable companies.

Stable Growth

The stable growth approach assumes that the company will continue to operate and generate cash flow that grows at a constant rate over the investment period and is reinvested. The terminal value in stable growth is the estimated cash flow discounted to the end of the initial investment period.

How Terminal Value Works

Terminal value is important in corporate finance for valuing companies in mergers and acquisitions and for some analysts working in investment firms. Some individual investors may incorporate terminal value into their analysis, but not all investment strategies require knowledge or understanding of this concept.

What This Means for Individual Investors

If your investment strategy relies on discounted cash flow valuation, you should understand and include terminal value in your investment evaluation process. Estimating terminal value is useful for individual investors who choose investments based on fundamental analysis because it provides a way to estimate the value of the investment after the period they believe they can achieve an accurate forecast.

Sources:

Aswath Damodaran. “Estimating Terminal Value.” Accessed Feb. 19, 2021.

Corporate Finance Institute. “DCF Terminal Value Formula.” Accessed Feb. 19, 2021.

Source: https://www.thebalancemoney.com/what-is-terminal-value-5113347