When building a discounted cash flow (DCF) model, we forecast future cash flows—usually over 5 to 10 years. But what happens after that? Businesses don't just stop operating. That's where terminal value comes in.

There are two main methods used to estimate terminal value:

Gordon Growth Model (Perpetuity Method)

This assumes the business grows at a constant rate forever. It's most appropriate for stable, mature companies. The formula is:

$\text{TV} = \frac{FCF_{n+1}}{WACC - g}$

Where $FCF_{n+1}$ is the cash flow in the first year after the forecast, $g$ is the perpetual growth rate, and WACC is the discount rate.

Exit Multiple Method

This applies a market multiple (e.g., EV/EBITDA) to a final year metric like EBITDA. It's often used when market comparables are available and provides a market-aligned snapshot.

Each method has its place. The Gordon Growth model is rooted in cash flow fundamentals, while the exit multiple method reflects prevailing market sentiment. In practice, analysts might use both and triangulate between them.

Regardless of the method, the terminal value must still be discounted back to present value using WACC, just like the earlier cash flows.

Terminal value is not a detail—it's often the largest driver in a DCF model. That's why it's critical to understand its logic and assumptions before relying on the results.