Terminal value approaches

In most DCF models, the terminal value, the value attributed to cash flows beyond the explicit forecast period, accounts for 60–80% of total enterprise value. This means that despite spending hours forecasting five or ten years of detailed cash flows, the result is dominated by a single, hard-to-estimate number.

This is simultaneously DCF's greatest strength and its most dangerous weakness. The strength: it forces analysts to articulate what long-run growth and profitability they're assuming. The weakness: small changes to these assumptions produce dramatic swings in value, making precision illusory.

There are two main approaches: the Gordon Growth Model (perpetuity assumption) and the Exit Multiple method (what would a rational buyer pay for this business in year n?). Both require judgment, and the best analysts use both as cross-checks.

Method 1: Gordon Growth Model (Perpetuity Growth) TV = FCFF_{n+1} ÷ (WACC − g) Where g = long-run perpetuity growth rate.

• FCFFₙ₊₁ = FCFFₙ × (1 + g)
• g must be less than WACC (otherwise TV → ∞)
• For India: g typically 4–7% in nominal terms (long-run GDP growth range)

Reinvestment rate check: g = Reinvestment Rate × ROIC If you assume g = 6% and ROIC = 15% in perpetuity, the implied reinvestment rate = 40%. Check: does this make sense for a mature business?

Method 2: Exit Multiple TV = EBITDA_n × EV/EBITDA exit multiple The exit multiple should reflect what a buyer would pay for a mature, stable version of this business. Use current trading multiples of comparable mature companies in the sector.

Cross-check: Given your exit-multiple-derived TV, back-solve for the implied perpetuity growth rate. If the exit multiple implies g = 9% when you're using WACC of 11% and India's long-run GDP is 6–7%, something is inconsistent.