# Approaches for Calculating the Terminal Value

The terminal value can be calculated using a:

• Single-stage (constant-growth) model.
• Valuation multiples approach.

Under the valuation multiples approach, there are two ways this can be done.

\begin{align*} & \text{Terminal value in year }n \\ &=\text{Justified trailing P⁄E}\times\text{Forecasted earnings in year }n\\ & \text{Terminal value in year }n \\ &=\text{Justified leading P⁄E}\times\text{Forecasted earnings in year }n+1\end{align*}

#### Example: Estimating Terminal Value with a P/E Multiple

The EPS of a particular company is estimated to be $5.00 in five years. The EPS in six years is estimated to be$5.90. If the median trailing industry P/E is estimated as 28, the terminal value in year 5 is closest to:

#### Solution

$$\text{Terminal value in Year 5}=28\times\5.00=\140$$

## Question

Given the following information,

• $$\text{EPS}_{2019}=2.30$$
• $$\text{EPS}_{2020}=3.00$$
• $$\text{EPS}_{2021}=3.50$$

If the median trailing industry P/E in 2020 is estimated to be 32, the terminal value in 2020 is closest to:

1. 73.6.
2. 96.0.
3. 112.0.

#### Solution

\begin{align*} & \text{Terminal value in year }n & \\ & =\text{Justified trailing P⁄E}\times\text{Forecasted earnings in year }n\\&=3\times32=96\end{align*}

Reading 24: Free Cash Flow Valuation

LOS 24 (l) Describe approaches for calculating the terminal value in a multistage valuation model.

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