Terminal value estimates a business’s value beyond the detailed forecast period in a discounted cash flow analysis.
Definition
A DCF model typically forecasts cash flows year by year for a defined period, then estimates value for the period after that forecast. This later estimate is terminal value. It may be calculated using a continuing growth assumption or an exit multiple applied to a final forecast measure. For a civil engineering firm, the assumptions may depend on expected long-term demand, staffing, margins, reinvestment, and the ability to sustain client relationships and project work. Because terminal value can be a substantial part of a model’s result, owners should understand the method and assumptions used. A different growth rate or exit multiple can change the estimate. Terminal value is not a separately realized payment, a guaranteed future sale price, or a prediction that current earnings continue unchanged. It is a model estimate that depends on the forecast and discounting assumptions. The AICPA provides resources on valuation services.
How owners use it
- Identify whether a model uses a continuing growth method or an exit multiple to estimate value after the detailed forecast.
- Check whether the terminal assumptions are consistent with long-term staffing, margins, and reinvestment needs.
- If final-year cash flow is $500,000, the assumed growth rate is 2%, and the discount rate is 10%, then $500,000 × 1.02 ÷ (0.10 - 0.02) = $6,375,000 before discounting to present value.
- Review how much of the model’s total value comes from terminal value and how sensitive it is to assumptions.
