Which statement best describes terminal value in a DCF and its estimation?

Which statement best describes terminal value in a DCF and its estimation?

• A. The initial investment required for the project.
• B. The sum of the forecast period cash flows.
• C. The value of all cash flows beyond the forecast period; often estimated using perpetuity growth or exit multiple.
• D. The present value of cash flows within the forecast period.

Answer: (C)

Terminal value in a DCF captures the value of all cash flows that occur after the explicit forecast period. Because it’s hard to forecast far into the future with precision, we estimate the continuing stream of cash flows beyond the horizon. The two common methods are a perpetuity growth model, which assumes cash flows grow at a stable rate forever and uses TV = FCF next year divided by (r minus g), and an exit multiple approach, which values the business based on a multiple of a metric like EBITDA at the end of the forecast period. This terminal value is then discounted back to present value along with the forecast-period cash flows to give the total enterprise value. The other statements miss this idea: the initial investment is the upfront outlay, not a value of future cash flows; the sum of forecast period cash flows ignores what comes after the horizon; and the present value of cash flows within the forecast period omits the value of cash flows beyond that period.

Terminal value in a DCF captures the value of all cash flows that occur after the explicit forecast period. Because it’s hard to forecast far into the future with precision, we estimate the continuing stream of cash flows beyond the horizon. The two common methods are a perpetuity growth model, which assumes cash flows grow at a stable rate forever and uses TV = FCF next year divided by (r minus g), and an exit multiple approach, which values the business based on a multiple of a metric like EBITDA at the end of the forecast period. This terminal value is then discounted back to present value along with the forecast-period cash flows to give the total enterprise value. The other statements miss this idea: the initial investment is the upfront outlay, not a value of future cash flows; the sum of forecast period cash flows ignores what comes after the horizon; and the present value of cash flows within the forecast period omits the value of cash flows beyond that period.