In a DCF analysis, what is a terminal value?

In a Discounted Cash Flow (DCF) analysis, the terminal value represents the value of an investment at the end of the explicit forecast period. This value captures the expected cash flows that an asset or business is anticipated to generate beyond the projection period, extending indefinitely into the future.

The terminal value is crucial because it accounts for a significant portion of the total valuation in a DCF model, especially for businesses expected to continue generating cash flows long after the initial forecast period. It is typically calculated using either the Gordon growth model (perpetuity method) or an exit multiple approach.

By estimating the terminal value, analysts can provide a more comprehensive view of the potential future cash flows and the overall worth of the investment, which helps in making informed decisions about the investment.