In what scenario would an analyst likely use a terminal value in a DCF model?

In a Discounted Cash Flow (DCF) model, the terminal value represents the value of a business at the end of the explicit forecast period, which is typically five years but can vary based on the specifics of the analysis. Analysts often use a terminal value when projecting cash flows beyond this forecast horizon because it captures the value of all future cash flows expected to be generated by the business beyond the initial projection period.

Using a terminal value helps to reflect the ongoing nature of the business and its capacity to generate cash flows indefinitely, even after the explicit projections are completed. It provides a more comprehensive valuation that accounts for the long-term potential of the company. This approach is crucial when it is understood that companies usually do not have a finite lifespan and can continue to generate value into the future.

In contrast, projecting cash flows for a company with unstable financial performance or limited historical data might lead an analyst to be hesitant about relying on terminal value calculations. High discount rates may influence the present value of future cash flows but do not inherently dictate the use of terminal value, which remains applicable when there is a need to estimate long-term value. Thus, the scenario where an analyst would likely use a terminal value is when cash flows are projected beyond a defined time frame, necess