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Learn Financial Modeling : Discounted Cash Flow statement (DCF) Methodology

3. Find our terminal Value

Terminal value represents all value beyond the explicit forecast period so from your 6 onward now it's hard to use a basic discounted cash flow formula to to calculate terminal value given that a extends into the future long into the future so we there's really two different methods to calculate terminal value the first one is what we call growth and perpetuity which is what we're going to do in our model and the second is what we call exit EBIT on multiple method but we're going to focus again on growth and perpetuity terminal value is a value that's assumed to exist in year 5 and so we're going to have to apply the discount factor from year 5 to this terminal value to arrive at the present value of stage 2 and our enterprise value will be that stage 1 plus stage 2 and so now that we know what terminal value is let's go ahead and and calculate it so a WACC again will be calculated later on so our free cash flow and t plus 1 is going to be this unlevered free cash flow times 1 plus the growth rate we take that free cash flow and we divide by WACC minus the growth rate again growth and perpetuity and the value

So the present value of terminal value is going to be this terminal value divided by 1 plus the WACC from the fifth period raised to the 5th power

For now we forecast that free cash flows 5 years into the future and we will discount those cash flows back to the present to arrive at the present value of what we call stage 1 we then estimated what the value beyond the explicit period will be using growth and perpetuity growth and perpetuity method the value beyond the explicit period is what we call terminal value

Next we will Understand and calculate WACC, the only factor remaining that we need to have the present value of the free cash flow and fill all the missing info in our DCF PART 4.