Terminal Value

Terminal value (sometimes called the residual value) is a process for estimating how much an asset or company will be worth down the road. If your company keeps making money year after year, you might think, “Okay, this year it’s making $100, next year maybe $110, then $120, and so on.” But you can’t keep adding up these numbers forever because it gets complicated. After a certain number of years, a company might settle into a steady pattern where it makes roughly the same amount of money each year. Terminal value is about finding a way to capture the total value of all those steady years in one number. Different methods are used to calculate this. A fair market value of an asset is calculated by applying a discount factor (reflecting the rate of return or the interest rate). If the terminal value is 50% or more of the total cash flows, this suggests the projected cash flows are weak and most of the asset’s value lies in the future. However, because future cash flows are uncertain, the terminal value is discounted to account for these doubts. Terminal value helps investors and companies get a sneak peek into the future.