The present value of all cash flows beyond the explicit forecast period in a DCF model — typically representing 60–80% of a company's total calculated intrinsic value.
Deeper Explanation
Terminal value dominates DCF valuations, which is both its importance and its danger. A tiny change in the terminal growth rate assumption (say, from 3% to 4%) can change the terminal value — and therefore the total intrinsic value — by 20–30%. Most investors underestimate this sensitivity. Two approaches exist: the perpetuity growth model (assumes a stable growth rate forever) and the exit multiple method (assumes the business will be sold at a specific EBITDA multiple). The perpetuity model requires honest assessment of long-run sustainable growth — using a rate above the economy's long-run GDP growth rate implies the business will eventually be larger than the entire economy, which is logically impossible.
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