In a DCF, which methods estimate Terminal Value?

In a DCF, which methods estimate Terminal Value?

• A. Multiples Method and Gordon Growth Method
• B. Straight-line depreciation
• C. Depreciation methods only
• D. Discounted cash flow method only

Answer: (A)

Terminal value in a DCF captures the value of all cash flows after the forecast period, so you need methods that extend value beyond the explicit projections. The two standard ways to estimate it are the Gordon growth (perpetuity) model and the multiples method. The Gordon growth approach assumes cash flows grow at a steady rate forever and uses the final year’s cash flow, the discount rate, and the perpetual growth rate to calculate TV. The multiples method applies a comparable industry multiple (like EV/EBITDA) to a metric in the final forecast year to infer enterprise value. These are the established ways to set a plausible long-run value. Straight-line depreciation is an accounting allocation of asset cost and doesn’t provide a method for valuing future cash flows. Saying “depreciation methods only” would not be a terminal value approach. And saying the DCF is the only method would ignore the practical, standard approaches (multiples and Gordon growth) used to estimate terminal value in practice.

Terminal value in a DCF captures the value of all cash flows after the forecast period, so you need methods that extend value beyond the explicit projections. The two standard ways to estimate it are the Gordon growth (perpetuity) model and the multiples method. The Gordon growth approach assumes cash flows grow at a steady rate forever and uses the final year’s cash flow, the discount rate, and the perpetual growth rate to calculate TV. The multiples method applies a comparable industry multiple (like EV/EBITDA) to a metric in the final forecast year to infer enterprise value. These are the established ways to set a plausible long-run value.

Straight-line depreciation is an accounting allocation of asset cost and doesn’t provide a method for valuing future cash flows. Saying “depreciation methods only” would not be a terminal value approach. And saying the DCF is the only method would ignore the practical, standard approaches (multiples and Gordon growth) used to estimate terminal value in practice.