Direct answer. Terminal value is the present value of all cash flows beyond the explicit DCF projection period. Two methods dominate: Gordon Growth (perpetuity) and Exit Multiple. Together they cross-check each other.
Terminal value usually drives more than half of DCF enterprise value. Defend it well or the entire valuation collapses.
Definition
Terminal value captures the value of cash flows after the explicit projection period. It is computed at the final projection year and discounted back to present using WACC.
Formulas
Two methods, written blind.
Gordon Growth: TV = FCF × (1 + g) / (WACC - g) Exit Multiple: TV = EBITDA × Exit Multiple
Plain-English Explanation
Gordon Growth assumes the business grows forever at a constant rate g, with WACC as the required return. Exit Multiple assumes a buyer or market values the business at year-N EBITDA times a multiple. Both estimate the same thing — what the business is worth at the end of the explicit window.
Why Bankers Care
Terminal value is where most DCF value lives. Drill the surrounding stack in DCF interview questions and pressure-test it in a live investment banking mock interview.
Interview Answer Framework
Use this every time.
- 1. Pick a method. Default to running both for cross-check.
- 2. Defend g or the multiple. Anchor g below long-run GDP; anchor multiples to comps.
- 3. Discount. Apply WACC to bring TV to present.
- 4. Cross-check. Implied multiple from Gordon vs implied g from Exit Multiple.
- 5. Sensitize. Show enterprise value across a g/WACC and multiple grid.
Numeric Example
Illustrative inputs at the end of year 5.
| Input | Value |
|---|---|
| FCF year 5 | 100 |
| Long-term growth g | 2.5% |
| WACC | 8.0% |
| Gordon Growth TV | 1,864 |
| Year 5 EBITDA | 200 |
| Exit multiple | 9.0x |
| Exit Multiple TV | 1,800 |
| Discount factor at 8% over 5y | 0.681 |
| PV of TV (Gordon) | 1,269 |
| PV of TV (Exit Multiple) | 1,225 |
Sensitivity
Always present TV with a sensitivity grid. Vary g and WACC for Gordon Growth, or vary exit multiple by half-turn increments. The grid is the answer to 'what could change this?'.
Common Traps
Where candidates lose points.
- g > WACC. Breaks the formula and implies infinite value.
- g above long-run GDP. The firm cannot outgrow the economy forever.
- Wrong FCF year. Use the year-N FCF (or year-N+1 in some conventions). Be explicit.
- Inconsistent EBITDA. Use a normalized year-N EBITDA, not a peak or trough.
- Forgetting to discount TV. TV sits at year N and must be PV'd to today.
How to Practice This Concept
Build TV both ways for three companies you cover, then defend cold in a timed investment banking mock interview. For the upstream input, see WACC interview answer.
What Candidates Get Wrong
- Choosing one method blindly. Run both. Use one to sanity-check the other.
- Aggressive growth assumptions. Above long-run GDP is not defensible.
- Forgetting to discount. TV sits at year N. Bring it to present.
- No sensitivity grid. Bankers expect to see a range, not a point.
Real Interview Insight
A common failure pattern: candidate uses 4% g vs 7% WACC, generating a TV that swallows the whole DCF, and cannot explain why g should be that high. The fix is to anchor g below long-run nominal GDP and cross-check the implied multiple against comps.
Stop reading. Defend terminal value cold.
Reading the formula is not the same as defending it. Run a Mock Interview now.
Frequently Asked Questions
Keep going
Continue with the wider topic: DCF Interview Questions