Calculating Terminal Value

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Calculate the Terminal Value Having estimated the free cash flow produced over the forecast period, we need to come up with a reasonable idea of the value of the company 's cash flows after that period - when the company has settled into middle-age and maturity. Remember, if we didn 't include the value of long-term future cash flows, we would have to assume that the company stopped operating at the end of the five-year projection period. The trouble is that it gets more difficult to forecast cash flows over time. It 's hard enough to forecast cash flows over just five years, never mind over the entire future life of a company. To make the task a little easier, we use a "terminal value" approach that involves making some assumptions…show more content…
EV = ($18.5M/1.11) + ($21.3M/(1.11)2) + ($24.1M/(1.11)3) + ($19.9M/(1.11)4) + ($21.3M/(1.11)5) + ($316.9M/(1.11)5) EV = $265.3M Therefore, the total enterprise value for The Widget Company is $265.3 million. Calculating the Fair Value of Equity But we are not finished yet - we cannot forget about debt. The Widget Company 's $265.3M enterprise value includes the company 's debt. As equity investors, we are interested in the value of the company 's shares alone. To come up with a fair value of the company 's equity, we must deduct its net debt from the value. Let 's say The Widget Company has $50M in net debt on its balance sheet. We subtract that $50M from the company 's $265.3M enterprise value to get the equity value. Fair Value of Widget Company Equity = Enterprise Value – Debt Fair Value of Widget Company = $265.3M - $50M =$215.3M So, by our calculations, the Widget Company 's equity has a fair value of $215.3 million. That 's it - the DCF valuation is complete. Having finished the DCF valuation, we can judge the merits of buying Widget Company shares. If we divide the fair value by the number of Widget Company shares outstanding, we get a fair value for the company 's shares. If the shares are trading at a lower value than this, they could represent a buying opportunity for investors. If they

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