What is terminal value?
Everything beyond the forecast horizon, compressed into one number. In an SME discounted cash flow it is usually 60 to 75 percent of the total valuation.
The value of everything happening after your forecast ends, compressed into a single figure and discounted like any other year. In an SME discounted cash flow it routinely accounts for 60% to 75% of the total answer.
Which means most of the model is decoration
If three quarters of the valuation comes from one assumption about the years beyond your horizon, the five years you modelled carefully are less important than they feel. This is not a flaw in the method — it is the method being honest about where value in a going concern actually sits.
The two ways to calculate it
| Method | Formula | The trap |
|---|---|---|
| Perpetuity growth | Final year cash ÷ (discount rate − growth) | Growth above 2–3% assumes you outgrow the economy forever |
| Exit multiple | Final year EBITDA × a multiple | You have reintroduced the multiple you were avoiding |
Run both. If they differ by more than a third, one assumption is carrying too much weight and you should find out which before someone else does.
The sanity check
Divide the terminal value by the final forecast year's EBITDA. If the implied multiple is well outside the normal range for a business of your size, the perpetuity growth rate is doing something unrealistic — usually assuming permanent growth above the rate of the wider economy.
DCF valuation explained has the worked figures; how to value a business covers when a DCF is worth building at all.