{"concept":{"id":69,"slug":"terminal-value","term":"Terminal value","shortDefinition":"The part of a DCF's value that captures all the cash flows a company will generate beyond the explicit forecast period.","longDefinition":"Terminal value is the piece of a DCF that captures the value of all the cash flows a company will generate after the explicit forecast period, assuming it keeps operating indefinitely with modest, sustainable growth. It's discounted to present value with the same rate as the explicit-period flows -- the company's cost of capital. By capturing the entire remaining future life of the business, not just a handful of years, terminal value usually represents most of a DCF's total value -- often more than half -- which makes it one of the components most sensitive to long-term growth assumptions."},"relations":{"requirement":[],"contrast":[],"related":[],"calculatedBy":[{"concept":{"id":68,"slug":"dcf","term":"DCF","shortDefinition":"A valuation method that estimates a company's value by projecting its future cash flows and bringing them to present value.","longDefinition":"DCF (discounted cash flow) is a valuation method that estimates a company's value from two pieces: the present value of the cash flows it will generate during an explicit forecast period -- usually five to ten years -- and the terminal value, which captures the value of all the flows it will generate beyond that period. Both pieces are discounted to present value using a rate that reflects the company's cost of capital. It's one of the two main families of valuation methods -- alongside comparable multiples -- and its result depends critically on the starting assumptions: the projection of future flows, the assumed long-term growth rate, and the discount rate used."}}]},"curricularPosition":[{"id":56,"moduleId":20,"slug":"what-is-terminal-value-and-why-does-it-concentrate-so-much-value-in-a-dcf","title":"What is terminal value and why does it concentrate so much value in a DCF?","summary":"You understand what terminal value is, why it represents the value of all flows beyond the explicit period, and why in practice it usually concentrates most of a DCF's total value.","bodyMarkdown":"## Objectives\n\nBy the end of this lesson you understand what terminal value is, why it represents the value of all flows beyond the explicit period, and why in practice it usually concentrates most of a DCF's total value.\n\n## Content\n\nThe previous lesson left the present value of the explicit period's cash flows calculated -- just a few years. But a healthy company, in principle, doesn't stop existing the day that projection ends: it keeps generating cash well beyond it. Terminal value is the piece of the DCF that captures the value of everything the company will generate after the explicit period.\n\nTo estimate it, you assume that, beyond the explicit period, the company keeps generating Free Cash Flow indefinitely, growing at a modest and sustainable pace -- no longer year by year with detailed assumptions like in the explicit period, but as a single estimate that summarizes that entire more distant future. That estimate, like the explicit period's flows, is discounted to present value with the same rate: the company's cost of capital.\n\nHere's why terminal value usually concentrates so much value: the explicit period covers only a few years, while terminal value captures, in a single figure, the value of every year that follows -- the entire remaining future life of the business, not just a handful of them. That's why, even discounted heavily for being further out in time, terminal value usually represents most -- often more than half -- of a DCF's total value.\n\nThis has an important consequence the next lesson develops: if terminal value depends on a very-long-term growth assumption, and that piece is usually most of the total value, small changes in that assumption can move a DCF's final result significantly.\n\n## Example\n\nTwo analysts can project nearly identical flows for a company's explicit period, but if they assume slightly different very-long-term growth rates for the terminal value, their total valuations can differ notably, even though they started from very similar initial data and projections.\n\n## Common mistakes\n\n- Treating terminal value as a minor or secondary figure compared to the explicit period -- in practice it's usually the largest part of the total value, not the smallest.\n- Assuming a company can grow indefinitely at a high rate -- the growth assumed for terminal value should be modest and sustainable over the very long term, not an extrapolation of the company's recent growth.\n\n## Summary\n\nTerminal value captures the value of all the cash flows a company will generate beyond the explicit forecast period, assuming it keeps operating indefinitely with modest growth. By capturing the entire remaining future life of the business, it usually represents most of a DCF's total value.\n\n## Self-check\n\nWhy does terminal value usually represent most of a DCF's total value?\n\nWhat kind of growth assumption is reasonable for terminal value, and why?","bodyHtml":"<h2>Objectives</h2>\n<p>By the end of this lesson you understand what terminal value is, why it represents the value of all flows beyond the explicit period, and why in practice it usually concentrates most of a DCF's total value.</p>\n<h2>Content</h2>\n<p>The previous lesson left the present value of the explicit period's cash flows calculated -- just a few years. But a healthy company, in principle, doesn't stop existing the day that projection ends: it keeps generating cash well beyond it. Terminal value is the piece of the DCF that captures the value of everything the company will generate after the explicit period.</p>\n<p>To estimate it, you assume that, beyond the explicit period, the company keeps generating Free Cash Flow indefinitely, growing at a modest and sustainable pace -- no longer year by year with detailed assumptions like in the explicit period, but as a single estimate that summarizes that entire more distant future. That estimate, like the explicit period's flows, is discounted to present value with the same rate: the company's cost of capital.</p>\n<p>Here's why terminal value usually concentrates so much value: the explicit period covers only a few years, while terminal value captures, in a single figure, the value of every year that follows -- the entire remaining future life of the business, not just a handful of them. That's why, even discounted heavily for being further out in time, terminal value usually represents most -- often more than half -- of a DCF's total value.</p>\n<p>This has an important consequence the next lesson develops: if terminal value depends on a very-long-term growth assumption, and that piece is usually most of the total value, small changes in that assumption can move a DCF's final result significantly.</p>\n<h2>Example</h2>\n<p>Two analysts can project nearly identical flows for a company's explicit period, but if they assume slightly different very-long-term growth rates for the terminal value, their total valuations can differ notably, even though they started from very similar initial data and projections.</p>\n<h2>Common mistakes</h2>\n<ul><li>Treating terminal value as a minor or secondary figure compared to the explicit period -- in practice it's usually the largest part of the total value, not the smallest.</li><li>Assuming a company can grow indefinitely at a high rate -- the growth assumed for terminal value should be modest and sustainable over the very long term, not an extrapolation of the company's recent growth.</li></ul>\n<h2>Summary</h2>\n<p>Terminal value captures the value of all the cash flows a company will generate beyond the explicit forecast period, assuming it keeps operating indefinitely with modest growth. By capturing the entire remaining future life of the business, it usually represents most of a DCF's total value.</p>\n<h2>Self-check</h2>\n<p>Why does terminal value usually represent most of a DCF's total value?</p>\n<p>What kind of growth assumption is reasonable for terminal value, and why?</p>","sortOrder":2,"readingMinutes":9,"difficulty":"Intermedio","url":"/en/academy/valuation/dcf/what-is-terminal-value-and-why-does-it-concentrate-so-much-value-in-a-dcf"}],"graphSummary":{"root":{"type":"concept","id":"69","depthFromRoot":0,"entity":{"type":"concept","slug":"valor-terminal","term":"Valor terminal","excerpt":"Parte del valor de un DCF que recoge todos los flujos de caja que la empresa generará más allá del periodo explícito de proyección."}},"depth":1,"returnedNodes":1,"truncated":false,"hasCycle":false,"nodes":[{"type":"concept","id":"69","depthFromRoot":0,"entity":{"type":"concept","slug":"valor-terminal","term":"Valor terminal","excerpt":"Parte del valor de un DCF que recoge todos los flujos de caja que la empresa generará más allá del periodo explícito de proyección."}}],"edges":[]},"relatedNews":[],"relatedEntities":[]}