Terminal Value plays an important role in enterprise valuation. What factors aff

Question

Terminal Value plays an important role in enterprise valuation. What factors affect the estimate of Terminal Value? How sensitive enterprise valuation is to Terminal value? After choosing a set of input parameters yourself or using the numbers givn below, please answer the following questions what percentage the terminal value contributes to the total enterprise value? How sensitive is your valuation to inputs? Suggested inputs: Gross Margin 40% Fixed Costs $2,000 Revenue Growth Rate for Years 1 to 5 10% FCF Steady Growth 3% Discount Rate 12% Year 1 Revenue $5,000 Tax Rate 35% Terminal Year 5

Explanation / Answer

Terminal value is the most important value contributor in the enterprise value. This is important from the fact that we can not forecast cash flows with certainity forever, say it makes logical to forecast cash flows for the next 5 years with the certainity of estimated growth rates and other key important value drivers. So after that we assume terminal stage where we make an estimation that the cash flows will grow at contsant rate say the long term nominal GDP growth or nominal risk free rate.

Terminal value is effected by the last explicit period cash flows, terminal growth rate and discount rate. Terminal value is the biggest value influencer in the EV it generally accounts for more than 60-80% of total enterprise value as it is present value of the cash flows in the infinite period.

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