Terminal Value

Definition

The residual value of a business at the end of a discrete income projection period used in the Discounted Cash Flow business valuation method.

What It Means

Discounted Cash Flow requires income stream projection over a finite period of time. If the business continues operating beyond this point in time, the residual business value must be accounted for.

It is what the business is worth above and beyond the present value of the projected income stream. This value represents a key input into the business valuation and is referred to as the terminal value.

Assuming that the business will continue operating indefinitely beyond year n at the end of the income projection period, the terminal value is determined as follows:

T = (CF n (1 + g)) ÷ (d - g)

Where CFn is the income measure expected to be received in year n, d is the discount rate, and g is the expected average annual growth rate in the income such as the business net cash flow. The difference between the discount rate and the expected average cash flow growth rate in the denominator above is the capitalization rate.