Terminal value
The value, at the end of an explicit forecast, of everything that follows — usually from a constant growth formula. It often supplies most of the total, so its growth assumption deserves the most scrutiny.
Where you will meet it
Terminal value appears in 18 learning outcomes on the CFA syllabus. A few of them:
- Use a dividend discount model with several growth stages
“A multi-stage model discounts an explicit forecast of dividends over a growth phase and then applies a terminal value, usually the constant growth formula, to the point at which growth has settled.”
- Justify the length of an explicit forecast period and how to project past its end
“Beyond the horizon, the analyst assumes a steady state and captures it in a terminal value, using either a perpetual growth formula, where terminal value equals the next year's cash flow divided by the discount rate minus the growth rate, or an exit multiple applied to the final year's earnings.”
- Set out what the Gordon growth model does well and badly and argue for using it to value a firm's common shares
“It suits mature dividend-paying companies with stable payout policies and growth close to that of the economy, and it is also used for broad market indices and for terminal values in multistage models.”
- Value a REIT share by discounted cash flow, by net asset value and by relative value using price-to-FFO and price-to-AFFO multiples, and interpret the results
“The discounted cash flow route forecasts dividends for a few years, adds a terminal value, often a multiple of the following year's AFFO, and discounts everything at the required return on equity.”
Practise it
Practise terminal value until it is automatic: questions that explain every wrong option.
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