Terminal Value & Terminal Growth Rate

Terminal Value

Terminal Value is a measure of a business’ value past the explicitly forecasted period. It usually contributes to between two-thirds and three-quarters of a Company’s total valuation.

It’s important to consider that terminal value is a projection out into perpetuity, meaning that the growth rate is much lower than the growth rate we used to project out the next 5 years, more on that in a second.

Terminal Value Formula - Gordon Growth Method

This is a technical question so I would write this down a few times to engrave it into your memory.

In our example, Final Year CF = 2030E Unlevered FCF and we’ll set the Terminal Growth Rate (TGR) to 2%. Commonly accepted TGRs are usually between 2% - 3%.

The reason the TGR is between 2% - 3% is that the TGR is based on the US Long-Term GDP growth rate and the US Long-Term inflation rate. These are both around 2-3% depending on where you set the goal post.

But, why do they have to fall within these bounds? Let’s say that the long-term inflation rate was 2% and you set the TGR to 4%. This implies that the company will grow at 4% into perpetuity. Meaning that due to compounding, the company will eventually become more valuable than the US economy, which is impossible since it is a part of the US economy.