Question

Why do we calculate terminal value when valuing a business?

Answer 1

1.Terminal value means the present value of the cash flows that a business or a company or an asset at a future point of time that it is able to generate when all the other things remaining constants i.e, When the required rate of return and growth rate of the cash flows are constant.

2.Terminal Value of the business will be calculated as the value of the business or the asset is the present value of the cash flows that the business or the particular asset is able to generate during its usage or lifetime.

3.It is nearly impossible to anyone to predict the cash flows of every year beyond a particular point of time, particularly when the life of business lasts more than 15years, thus we can only make certain presumptions that the company's cash flows grow at certain rate and at its required rate of return.

4.Thus, as the value of the business includes its life time cash flows and due to our inablility to find all cash flows of the future, we will calculate terminal value of the business or asset based on the presumptions and expectations build based on the previous data.