Terminal value is the measure of a business’ value beyond what’s been estimated as cash flows for the future (typically 5 years).
So in this measure it’s implied that the business will grow forever.
It considers expected free cash flows, the estimated growth rate and the cost of capital.
The formula, calculated with the perpetuity method, is:
The growth rate could be around the company’s country GDP or less.
The cost of capital depends on how much company’s lenders and shareholders are remunerated.
Then a higher growth rate makes the terminal value increase and vice versa.
While a higher cost of capital, which reflects the business risk, makes the terminal value decrease and vice versa.
➠ this method is more ’’academic’’, since in practice it is usual to utilize also the formula that multiplies a financial metric (like EBITDA or revenues) by a ’’multiple’’, that reflects both the company and its sector.
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