In a DCF, which methods are used to calculate terminal value?

In a DCF, which methods are used to calculate terminal value?

• A. Discounted payback
• B. Perpetuity method or terminal multiple method
• C. Mid-year convention
• D. Only explicit forecast

Answer: (B)

In a DCF, terminal value represents the value of all cash flows beyond the explicit forecast period, so you need a method to estimate that continuing value. The two standard approaches are the perpetuity growth method (often called the Gordon growth model) and the terminal multiple method. The perpetuity approach assumes cash flows grow at a stable rate forever, so TV = next period’s cash flow divided by (discount rate minus the growth rate). The terminal multiple approach uses a comparable multiple (like EV/EBITDA or EV/FCF) applied to a metric at the end of the explicit forecast to derive value. The other options don’t provide a way to estimate this continuing value: discounted payback is a timing/payback measure, not a terminal value method; the mid-year convention affects when cash flows are considered but not how the terminal value is calculated; and using only the explicit forecast would ignore the value beyond the forecast, which is generally essential in a DCF.

In a DCF, terminal value represents the value of all cash flows beyond the explicit forecast period, so you need a method to estimate that continuing value. The two standard approaches are the perpetuity growth method (often called the Gordon growth model) and the terminal multiple method. The perpetuity approach assumes cash flows grow at a stable rate forever, so TV = next period’s cash flow divided by (discount rate minus the growth rate). The terminal multiple approach uses a comparable multiple (like EV/EBITDA or EV/FCF) applied to a metric at the end of the explicit forecast to derive value. The other options don’t provide a way to estimate this continuing value: discounted payback is a timing/payback measure, not a terminal value method; the mid-year convention affects when cash flows are considered but not how the terminal value is calculated; and using only the explicit forecast would ignore the value beyond the forecast, which is generally essential in a DCF.