What are the main approaches to estimating DCF terminal value?

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AcadiFi · Accepted Answer

Terminal value captures cash flows beyond the explicit forecast horizon and often represents 60-80% of total DCF value — making the method choice critical.

**1. Gordon Growth (Perpetuity with Constant Growth).** TV = FCFF_{n+1} / (WACC − g). Assumes cash flows grow at constant rate g forever. Use when: firm reaches mature steady state by end of explicit period. Weakness: extreme sensitivity to small changes in g.

**2. Exit Multiple.** TV = Terminal EBITDA × Exit Multiple. Applies a market multiple (typically current trading or historical median) to terminal-year EBITDA, revenue, or earnings. Use when: reasonable peer multiples exist and firm is expected to resemble peers by the terminal year. Weakness: circular logic — using market multiples to value a company relies on market prices, which is what you're trying to validate.

**3. H-Model.** Blends a declining growth stage with stable growth, useful when transition to steady state is gradual rather than abrupt.

**4. Liquidation Value.** Sum of breakup asset values minus liabilities. Used for declining businesses where going-concern assumption is inappropriate.

**5. Replacement Value.** Cost to replicate the business. Used as floor for asset-heavy firms.

Best practice: use multiple methods and compare. For Brookline Foods: Gordon at 2.5% growth and 8% WACC gives TV of $2.8B. Exit multiple at 9x EBITDA gives TV of $2.4B. The $400M gap signals one method is inconsistent with the other. Check: Gordon's implied multiple = $2.8B / $270M = 10.4x, higher than peer 9x. Reconcile by adjusting g or reconsidering whether current peers' multiple will persist.

What are the main approaches to estimating DCF terminal value?

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