If you’ve ever built a DCF model, you know that most of the company’s value doesn’t come from the next five years of cash flow—it comes from what happens after that. That’s where terminal value comes in.
Terminal value captures the ongoing value of a business beyond the explicit forecast period, usually in perpetuity or until a hypothetical exit. In many models, it accounts for 60% to 80% of the total valuation—sometimes more. That means small changes in how it’s calculated can have a big impact on your final number.
But terminal value isn’t just a plug at the end of a model. It’s a financial statement about what the business looks like long-term, after things stabilize. Get it right, and your model becomes a credible forecast. Get it wrong, and you’ve built a castle on shaky assumptions.
In this article, we’ll break down what terminal value is, how to calculate it using the two most common methods, and how to judge whether your assumptions actually make sense.
What Is Terminal Value?
Terminal value estimates the value of a company’s cash flows beyond the forecast period, usually from year 6 onward. Since it’s impossible to project detailed financials forever, terminal value simplifies the rest of the company’s life into a single number—based on an assumption about steady-state growth or exit pricing.
It reflects a simple truth: most businesses don’t shut down after 5 or 10 years. They continue operating, earning, and investing—ideally at a more stable and mature pace. Terminal value captures that ongoing value, so it can be reflected in today's valuation.
There are two main ways to calculate it:
- The Gordon Growth Method (also called Perpetuity Growth)
- The Exit Multiple Method
Each has its place, and each tells a slightly different story about how you see the company’s future.
Method 1: Gordon Growth Model (Perpetuity Method)
This method assumes that after the forecast period, the company will grow its free cash flows at a constant, modest rate forever—typically 1% to 3%, in line with long-term inflation or GDP growth.
Here’s the formula:
Terminal Value = Final Year FCF × (1 + g) / (WACC – g)
Where:
- FCF = Free Cash Flow in the final forecast year
- g = Long-term growth rate
- WACC = Discount rate
For example, if year 5 free cash flow is $50 million, the growth rate is 2%, and WACC is 8%, then:
Terminal Value = $50M × (1 + 0.02) / (0.08 – 0.02) = $51M / 0.06 = $850 million
This $850 million is then discounted back to today like any other future cash flow.
What it tells you:
This approach is grounded in fundamentals. It reflects the value of the company as a stable, cash-generating asset beyond the high-growth period. It works well for mature companies in predictable industries.
Where it breaks down:
If you use an unrealistic growth rate (like 5% or more), the denominator shrinks, and terminal value explodes. And since this method assumes the company lasts forever, it may not be ideal for businesses facing structural decline or disruption.
Method 2: Exit Multiple Method
This method assumes the company will be sold at the end of the forecast period for a price based on a market multiple—like EV/EBITDA, EV/EBIT, or EV/Revenue.
Here’s the formula:
Terminal Value = Final Year Metric × Chosen Exit Multiple
So if year 5 EBITDA is $100 million, and you assume an exit multiple of 9×, the terminal value is:
Terminal Value = $100M × 9 = $900 million
This value also needs to be discounted back to today.
What it tells you:
This method anchors your model in real market data—comparable company multiples or precedent M&A transactions. It’s often used in private equity models, where an actual exit is expected.
Where it breaks down:
The exit multiple is a huge swing factor. Using too high a multiple can inflate value unjustifiably, especially if you haven’t thought about what the business will look like in five years. Also, it implicitly assumes the market at that future point will value the company similarly to today.
How Terminal Value Affects the Whole DCF
In most DCFs, terminal value makes up the majority of the enterprise value. That’s why it’s critical to:
- Stress test your assumptions (e.g. what happens if the growth rate drops or the multiple compresses?)
- Check that terminal value isn’t disproportionately large compared to the forecasted period
- Use both methods when possible to triangulate a defensible range
Terminal value isn't about getting it "exact." It's about making sure the long-term story your model tells is reasonable, transparent, and aligned with market logic.
Closing Thoughts
Terminal value isn’t just a technical step in a DCF—it’s where your long-term view of the business is condensed into one number. Whether you use a perpetuity growth model or an exit multiple, your assumptions here say more than you might realize. They signal what kind of business this becomes after growth slows, what investors are likely to pay for it, and how sustainable its economics really are.
The best valuation practitioners don’t just plug in a growth rate or multiple. They ask whether those inputs make sense in the context of the industry, the company’s position, and real market behavior. And they always check how much weight terminal value carries in the total.
Because when most of your valuation depends on what happens after year five, that part of the model deserves just as much scrutiny as anything else.