Terminal value makes up most of your enterprise value. Is that a problem?

Say it's normal, often 60% to 80% of a DCF, because a long-lived business earns most of its value after the forecast. Then normalize the final year, cross-check both methods, show sensitivities, and worry above about 85%.

The numbers, step by step

The example from the answer: $100 of free cash flow next year, 2% growth forever and a 10% WACC.

Value of the whole stream$100 ÷ (10% − 2%)

$1,250

Value of the first five years$1,250 × (1 − (1.02 ÷ 1.10)^5)

$393

Share of value after year five($1,250 − $393) ÷ $1,250

69%

What the interviewer listens for

• Do you say it's normal and explain why?
• Do you give a typical range or work an example?
• Do you name the sensitivity it creates and show it?
• Do you know when the share becomes a red flag?

Common mistakes

• Treating a high terminal value share as proof the DCF is wrong.It's normal for long-lived businesses.
• Brushing it off.It makes the answer sensitive to a few inputs, which a sensitivity table has to show.
• Shortening the forecast to fix it, which pushes the terminal value share up.

Likely follow-ups

• Does the exit multiple method avoid this?No. The share is similar, and the value then also depends on today's market multiples.
• What share would you expect for an early-stage company?Close to 100%, sometimes above it, because early cash flows are negative. That's one reason a DCF is weak there.
• How would you reduce the reliance on terminal value?Extend the forecast so more value sits in explicit years, normalize the final year, and give comps and precedents more weight in the conclusion.

More finance technicals

• A company with no debt, worth $10 billion with 100 million shares at $100, borrows $1 billion at 6% to pay a special dividend. What happens to its WACC, enterprise value, equity value and share price?
• Walk me through a DCF.
• What is WACC and how do you calculate it?
• What is the difference between enterprise value and equity value?
• How would you value a company?

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