Terminal value is a financial term that describes today's value, or present value, of an investment that is expected to grow indefinitely at a stable rate. Terminal value can be applied most realistically to perpetuity annuities, an investment that returns cash payments forever. However, terminal value can also be used for any asset that has no discernible end date, such as a business or bank account.
Gordon Growth Model
The Gordon Growth Model is the most common method of calculating terminal value. The first step is to determine an asset's present value for the foreseeable future. The final year of the foreseeable future is the growth rate used to determine the company's "perpetuity growth rate" which is based on factors such as inflation and the asset's cost of capital.
Example of Terminal Value
A child opening a bank account is a good example of an asset with no discernible end date. Assume he opens this account with $10 today. The growth rate is expected to be 1 percent. The asset's cost of capital, including the inflation rate, is 5 percent. The terminal value is calculated as $10 *(1 + 0.01) / 0.05 - 0.01 = $252.
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