Plain definition
Terminal value estimates the value of cash flows after an explicit forecast ends. In a discounted cash-flow valuation it can be based on a stable-growth formula or an exit assumption, then discounted back with the forecast cash flows. It often represents a large share of total value, so it must be visible rather than treated as a spreadsheet remainder.
A perpetual-growth approach needs cash flow that is sustainable after the transition period, a discount rate consistent with that cash flow, and a long-run growth rate below the discount rate. It is not a license to extend a temporary launch margin forever.
Illustrative example
Monetary examples use Saudi riyals (SAR). The same principles apply in other currencies.
Suppose year-six free cash flow is expected to be after a business has reached a stable state. With a 10% required return and 3% long-run growth, terminal value at the end of year five is : 110,000 ÷ (10% − 3%). That number is then discounted to today separately.
If the result drives most of the valuation, management should ask what evidence supports stable cash flow, margin, reinvestment, and growth—not merely whether the formula has been entered correctly.
| Year-six free cash flow | |
|---|---|
| Capitalisation factor 1 ÷ (10% − 3%) | |
| Terminal value at end of year five |
Terminal value is an estimate at a date, not cash already earned or a guaranteed sale price.
Why it matters
It prevents a long-lived business from being valued as though it ends when the detailed forecast ends, but it can also hide an aggressive assumption behind a single large number.
Practical consequence
Show terminal value separately from forecast-period value. State the terminal-year cash flow, growth, discount rate, date, and business conditions required for stability. Test lower cash flow, lower growth, and a higher rate; if a small change reverses the conclusion, make the evidence needed for the assumption part of the approval.