Terminal value is the present value of every cash flow beyond the explicit forecast period — in practice, year 6 to infinity. In a typical 5-year DCF, terminal value is 65-85% of total enterprise value. This is where DCFs are won or lost. Spend most of your sanity-checking effort here.
The Gordon growth (perpetuity) method
Terminal Value = FCF(year 6) / (WACC − g)where g = perpetual growth rate
This is the standard textbook formula. It requires a perpetual growth rate that is below WACC (otherwise the formula explodes) and above zero (otherwise the business is shrinking forever, which is rarely true for going concerns). The economically defensible range is between long-term inflation and long-term real GDP growth — for most developed markets, 2-3%; for Kenya, perhaps 4-6% nominal, depending on inflation expectations.
The exit multiple method
Terminal Value = EBITDA(year 5) × Exit multiplewhere Exit multiple is observed in current comparables
Multiply the year-5 EBITDA by an EV/EBITDA multiple drawn from current comparable companies, on the assumption the company exits at a similar multiple. This is the practitioner's preferred method because it grounds terminal value in observable market reality rather than a perpetuity assumption that no one can verify.
Cross-check the two methods
Always compute both. If your Gordon growth model implies an exit multiple of 30x and your comparables trade at 10x, something is wrong — either your discount rate is too low, your perpetual growth is too high, or both. Conversely, if your exit multiple implies a perpetual growth rate of 8% (which it might, with low WACC), you have an unrealistic terminal valuation that needs revisiting.
TV is the answer most of the time
If you tweak revenue growth in year 1 by 1%, the answer barely moves. If you tweak the perpetual growth rate by 0.5%, the answer can move 15%. Your sensitivity tables should focus on TV inputs (g, exit multiple) and WACC, not on early-period operating assumptions.
The discount factor for TV
TV is computed at year 5 (the end of the explicit period) and must be discounted back to today at the same WACC as the explicit cash flows. Use the year-5 discount factor (1 / (1 + WACC)^5), not year 6. This is a one-line error that turns up in surprisingly senior models.
Exercise
A 5-year DCF on a Kenyan industrial gives the following explicit-period FCFF: Y1 800, Y2 920, Y3 1,050, Y4 1,180, Y5 1,300 (all in KES millions). WACC is 15%. Year-6 FCFF is forecast at KES 1,365m. Compute terminal value via both methods, then assemble the full enterprise value. (1) Gordon growth at g = 4%. (2) Exit multiple at 7x EBITDA, with Y5 EBITDA = KES 2,000m. (3) Reconcile the two — what does each imply about the other? (4) What proportion of EV does terminal value represent in each case, and is that reasonable?