Which statement is true about terminal value in a DCF?

Which statement is true about terminal value in a DCF?

• A. Perpetuity method or terminal multiple method
• B. It is always zero
• C. It uses only last forecast year FCF
• D. It ignores WACC

Answer: (A)

In a DCF, terminal value captures the value of all cash flows that occur after the explicit forecast horizon. It is estimated using two common approaches: the perpetuity growth model and the exit multiple method. With the perpetuity growth method, you project that cash flows grow at a stable rate forever. The terminal value is calculated as TV = FCF in year t+1 divided by (WACC minus the long-run growth rate g). This reflects ongoing cash generation starting after the last forecast year and into perpetuity, and it is then discounted back to present value at the WACC. With the exit multiple method, you apply a chosen multiple (based on comparable companies) to a metric in the terminal year, such as EBITDA or free cash flow, to estimate TV, which is again discounted back at the WACC. Key points: the terminal value is not zero, it relies on WACC in the discounting, and it does not rely solely on the last forecast year’s FCF—the perpetuity approach uses a growth rate beyond that year, and the exit multiple approach uses a multiple of a terminal metric.

In a DCF, terminal value captures the value of all cash flows that occur after the explicit forecast horizon. It is estimated using two common approaches: the perpetuity growth model and the exit multiple method.

With the perpetuity growth method, you project that cash flows grow at a stable rate forever. The terminal value is calculated as TV = FCF in year t+1 divided by (WACC minus the long-run growth rate g). This reflects ongoing cash generation starting after the last forecast year and into perpetuity, and it is then discounted back to present value at the WACC.

With the exit multiple method, you apply a chosen multiple (based on comparable companies) to a metric in the terminal year, such as EBITDA or free cash flow, to estimate TV, which is again discounted back at the WACC.

Key points: the terminal value is not zero, it relies on WACC in the discounting, and it does not rely solely on the last forecast year’s FCF—the perpetuity approach uses a growth rate beyond that year, and the exit multiple approach uses a multiple of a terminal metric.