In a discounted cash flow valuation, what is terminal value?

• A. The value of cash flows beyond the forecast horizon; affects enterprise value; often a large contributor to PV
• B. The present value of near-term cash flows
• C. A fixed percentage of revenue
• D. Irrelevant to valuation

Answer: (A)

Terminal value is the value today of all cash flows expected to occur after the explicit forecast horizon in a discounted cash flow valuation. Since we can’t forecast indefinitely, the terminal value captures the ongoing business value beyond the forecast period, usually via a perpetual growth assumption or an exit multiple, and it’s discounted back to present value along with the forecasted cash flows. Because many years of generating cash flow lie beyond the forecast window, the terminal value often represents a large portion of the total present value and thus drives the enterprise value. It’s not simply the present value of near-term cash flows, not a fixed percentage of revenue, and it’s certainly not irrelevant to valuation.