Enter the free cash flow value in the selected currency.
Enter the growth rate as a percentage.
Enter the required rate of return as a percentage.
History:

Explanation

What is Terminal Value?

Terminal value is a financial metric used to estimate the value of a business beyond the explicit forecast period, extending indefinitely into the future. It represents the present value of all future cash flows when a business is expected to grow at a stable rate. This calculation is crucial for investors and analysts when assessing the long-term viability and profitability of a business.

How to Calculate Terminal Value?

The terminal value can be calculated using the Gordon Growth Model, which is expressed with the following formula:

Terminal Value (TV) is calculated as:

§§ TV = \frac{FCF \times (1 + g)}{r - g} §§

where:

  • § TV § — terminal value
  • § FCF § — free cash flow in the last forecasted year
  • § g § — growth rate of free cash flow (as a decimal)
  • § r § — required rate of return (as a decimal)

This formula assumes that the free cash flow will continue to grow at a constant rate indefinitely after the forecast period.

Example Calculation

  1. Free Cash Flow (FCF): $1,000
  2. Growth Rate (g): 5% (0.05 as a decimal)
  3. Required Rate of Return (r): 10% (0.10 as a decimal)

Using the formula:

§§ TV = \frac{1000 \times (1 + 0.05)}{0.10 - 0.05} = \frac{1000 \times 1.05}{0.05} = \frac{1050}{0.05} = 21,000 §§

Thus, the terminal value of the business is $21,000.

When to Use the Terminal Value Calculation Calculator?

  1. Business Valuation: When assessing the overall value of a business for investment or acquisition purposes.

    • Example: Investors looking to buy a company will use terminal value to estimate its future cash flows.

  2. Financial Modeling: In creating financial models for forecasting and valuation.

    • Example: Analysts use terminal value in discounted cash flow (DCF) models to determine the present value of future cash flows.

  3. Investment Analysis: To evaluate the potential return on investment.

    • Example: Investors can compare the terminal value against the current market value to identify undervalued or overvalued stocks.

  4. Strategic Planning: For long-term business planning and strategy development.

    • Example: Companies can use terminal value to assess the impact of growth strategies on their overall valuation.

Key Terms Defined

  • Free Cash Flow (FCF): The cash generated by a company after accounting for capital expenditures. It is an important measure of a company’s financial performance.

  • Growth Rate (g): The expected rate at which a company’s free cash flow will grow indefinitely. This rate is often based on historical growth rates or industry averages.

  • Required Rate of Return (r): The minimum return that investors expect to receive for the risk of investing in a company. It is often based on the cost of capital.

Practical Examples

  • Mergers and Acquisitions: A company looking to acquire another may use terminal value to determine if the purchase price is justified based on future cash flows.

  • Startups: Entrepreneurs can use terminal value to present potential investors with a clear picture of the long-term value of their business.

  • Investment Funds: Fund managers may calculate terminal value to assess the potential growth of their portfolio companies.

Use the calculator above to input different values and see the terminal value change dynamically. The results will help you make informed decisions based on the financial data you have.