Terminal value in a valuation model

When valuing a company, a key part of the valuation is not just the cash flows that'll be generated for the next few years, but ultimately, what the company is going to be worth far down the road, what we call the terminal value. I'm in the 04_03_Begin Excel file. Now, we're going through and determining the value for this particular firm. We've already figured out that the present value of its free cash flows are over the next few years. The firm also has $5,000 in free cash on its balance sheet that we can use as part of our evaluation. What we need to figure out though is how much that firm is going to be worth in 2024 and beyond. And this is where the concept of the terminal value comes in. So the terminal value is simply going to be equal to the previous year's free cashflow times one plus the growth rate. Now, we're going to have to make an assumption about what our long term growth in this company is going to be. In this case, we've assumed it's 5% for the year 2024 and beyond. In other words, how fast will that company grow in perpetuity for the long run? We'll assume it's 5%. Finally, we're going to have to go through and divide by the discount rate minus our growth rate. And doing that then gives us the terminal value. So in this particular case, we see that the firm is worth, after adjusting, roughly $2,054,105. Now, that's the value in 2024, but we're not especially interested in the value in 2024, we want to know about the value today. So to figure that out, we're going to need to use our old friend, the present value formula. So I'll take that from the previous cell and we'll apply it here to our terminal value. So, first we need to determine our rate. Our rate is our discount rate. We're going to leave that the same. Next, we need to know how far in the future that terminal value occurs. Well, it's in 2024. At present, in the model, it's 2018, so we'll use six years down the road. We're getting no payment beyond that terminal value. The terminal value is our future value, and that'll be received at the end of that 2024 year. So what's the present value here? Well, it's going to be $1,368,736, and I'll clean this up by taking away the decimal places. To do this, if you're wondering how I do that so fast, I hold down the Control key and hit the number one. Now, we're ready to go through and determine the total value of the firm based on all of these different components. This is what we refer to as the discounted cashflow model. This is simply going to be the sum of all of these individual discounted cash flows for the period from 2018 at present through 2024. And this will tell us that the intrinsic value of the firm is $1.501 million. Now you're ready to apply a DCF model to your own financial forecasts.