Terminal value in a DCF is used to capture cash flows beyond the projection period. True or false?

Terminal value in a DCF is used to capture cash flows beyond the projection period. True or false?

• A. True
• B. False
• C. It replaces the need to discount future cash flows.
• D. It equals the final year's FCF

Answer: (A)

In a DCF, you project cash flows for a finite horizon because you can’t forecast forever, so you need a way to capture the value of all cash flows that occur after that forecast period. The terminal value does exactly that: it estimates the value today of all future cash flows from the end of the explicit forecast onward, typically using either a perpetual growth (Gordon) model or an exit multiple approach. This terminal value is then discounted back to present value along with the explicit cash flows to form the total enterprise value. So the statement is true because the terminal value serves to account for the continuing cash flows beyond the projection window, rather than replacing discounting or equaling the final year's cash flow.

In a DCF, you project cash flows for a finite horizon because you can’t forecast forever, so you need a way to capture the value of all cash flows that occur after that forecast period. The terminal value does exactly that: it estimates the value today of all future cash flows from the end of the explicit forecast onward, typically using either a perpetual growth (Gordon) model or an exit multiple approach. This terminal value is then discounted back to present value along with the explicit cash flows to form the total enterprise value.

So the statement is true because the terminal value serves to account for the continuing cash flows beyond the projection window, rather than replacing discounting or equaling the final year's cash flow.