How to use the terminal value calculator
Both tools value the business at the end of your forecast, then discount that value to today.
Perpetuity growth, the Gordon growth method:
- Final-year free cash flow, in millions of dollars: the cash flow in the last year of your forecast. It should be a normal, sustainable year.
- Perpetual growth rate: how fast that cash flow grows forever after.
- Discount rate, usually the WACC, and N, the number of years until the terminal value (the length of the forecast).
- Optionally, an FCF conversion rate to see the EV/EBITDA multiple the value implies, and the PV of the forecast cash flows to see the terminal value’s share of enterprise value.
Exit multiple values the business as a multiple of its final-year EBITDA. Enter EBITDA, the multiple, the discount rate, N and the share of EBITDA that turns into free cash flow, and the calculator shows the perpetual growth the multiple implies.
The formulas
PV of TV = TV ÷ (1 + r)NFCFN is free cash flow in the final forecast year, g the perpetual growth rate, r the discount rate and N the number of years until the terminal value. Valid only when g is below r.
Implied growth g = (TV × r − FCFN) ÷ (TV + FCFN)
Implied multiple = TV ÷ EBITDAN, with EBITDAN = FCFN ÷ conversionThe implied growth formula is the Gordon formula solved for g. Conversion is free cash flow as a share of EBITDA.
A worked example
Perpetuity growth. Company A’s forecast runs 10 years and ends with free cash flow of $1,200M. Growing at 2.5% forever and discounted at 9%, the cash flows after the forecast are worth $18.92B at that point, 15.8× the final cash flow. Discounted back over 10 years with a factor of 0.4224, the terminal value is worth $7.99B today. Added to $6,500M for the forecast years, that gives an enterprise value of $14.49B, of which the terminal value supplies 55.2%.
Exit multiple. If the final-year EBITDA is $2,000M and similar mature companies trade at 10 times EBITDA, the terminal value is $20.00B, worth $8.45B today. With 60% of EBITDA converting to free cash flow, that multiple implies perpetual growth of 2.83%.
Cross-checking the two methods
Each method hides an assumption the other makes explicit. The growth method hides a multiple: at 2.5% growth, the example implies an EV/EBITDA of 9.5×. The exit multiple hides a growth rate. Converting one into the other is the quickest test of whether a terminal value is reasonable:
| Exit multiple | Implied perpetual growth | PV of terminal value |
|---|---|---|
| 8× | 1.40% | $6.76B |
| 10× (the example) | 2.83% | $8.45B |
| 12× | 3.81% | $10.14B |
| 15× | 4.81% | $12.67B |
At 15× the implied growth is 4.81% a year forever, more than most analysts would accept for a mature company. A multiple taken from today’s market for a fast-growing peer often fails this test, because the business at the end of the forecast should be mature, not fast growing.
Why terminal value is so sensitive
The Gordon formula divides by r − g, the gap between two rates that are each uncertain by a point or more. In the example the gap is 6.5 points; narrowing it by half a point raises the terminal value by about 8% to 9%. The present value of the terminal value moves like this:
| Change from the example | PV of terminal value |
|---|---|
| The example (growth 2.5%, rate 9%) | $7.99B |
| Growth 2% instead of 2.5% | $7.39B |
| Growth 3% instead of 2.5% | $8.70B |
| Discount rate 8% instead of 9% | $10.36B |
| Discount rate 10% instead of 9% | $6.32B |
The discount rate matters twice: it sets the capitalization rate and discounts the result back N years. That is why one point on the rate moves the value more than half a point on growth. The sensitivity grid under the calculator shows the full range.
Common mistakes
- Not discounting the terminal value. It sits at the end of year N and must be brought back to today.
- Using a peak or depressed final year. The final cash flow is multiplied by a large number, so any one-off in it is multiplied too.
- Inconsistent reinvestment. A business cannot grow forever without investing. If capital spending in the final year barely exceeds depreciation, high perpetual growth is not funded.
- Mixing nominal and real rates. A nominal discount rate needs a nominal growth rate, which includes inflation.
What this calculator does not include
The calculator assumes cash flows arrive at the end of each year. Many practitioners use a mid-year convention, which raises present values slightly. It values one terminal year and assumes a constant growth rate afterwards; some models add a fade period in which growth and returns decline gradually. The exit multiple is applied to EBITDA only, and the result is an enterprise value: debt and cash still have to be accounted for to reach the value of the shares, as the DCF calculator does.