Definition

Discounted Free Cash Flow Terminal (DFCF Terminal) Value is a financial metric used to estimate the value of a business beyond the explicit forecast period in a discounted cash flow (DCF) analysis. It represents the present value of all future free cash flows when a company is assumed to grow at a stable rate indefinitely.

How to use the valuation method

To use the DFCF Terminal Value method, first project the free cash flows for a specific forecast period. Then, calculate the terminal value using the formula above and discount the terminal value back to the present value using the discount rate and add it to the present value of the forecasted free cash flows. Next add the cash per share value and minus the debt per share value to determine the total enterprise value.

Which industries it work best in

The DFCF Terminal Value method works best in stable and mature industries where companies have predictable cash flows and growth rates. Examples include utilities, consumer staples, and large-cap industrials.

Which industries it does not apply to and why

This method does not apply well to industries with high volatility, unpredictable cash flows, or rapid technological changes, such as startups, biotech, or tech companies. These industries often have uncertain growth prospects and cash flow patterns, making it difficult to accurately estimate a perpetual growth rate.

Summary

The Discounted Free Cash Flow Terminal Value is a key component of DCF analysis, used to estimate the value of a company beyond the forecast period. It is most effective in stable industries with predictable growth and cash flows but is less applicable to volatile or rapidly changing sectors.