{"id":17824,"date":"2021-07-15T17:33:30","date_gmt":"2021-07-15T17:33:30","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=17824"},"modified":"2026-03-19T18:27:23","modified_gmt":"2026-03-19T18:27:23","slug":"terminal-value","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/terminal-value\/","title":{"rendered":"Terminal Value"},"content":{"rendered":"<script type=\"application\/ld+json\">\r\n{\r\n  \"@context\": \"https:\/\/schema.org\",\r\n  \"@type\": \"QAPage\",\r\n  \"mainEntity\": {\r\n    \"@type\": \"Question\",\r\n    \"name\": \"Calculate terminal value using EPS growth and trailing P\/E\",\r\n    \"text\": \"A company\u2019s current EPS of $2.50 is expected to grow at 12% for 8 years. After that, it will decline to a long-term rate of 4%. If the trailing P\/E at the end of the high growth stage is 9, the terminal value is closest to:\\n\\nA. $22.55.\\n\\nB. $57.80.\\n\\nC. $55.70.\",\r\n    \"answerCount\": 1,\r\n    \"acceptedAnswer\": {\r\n      \"@type\": \"Answer\",\r\n      \"text\": \"The correct answer is C.\\n\\nEPS in year 8 = 2.50 \u00d7 (1.12)^8 = 6.19.\\n\\nTerminal value = 6.19 \u00d7 9 = 55.71, which is closest to $55.70.\"\r\n    }\r\n  }\r\n}\r\n<\/script>\r\n<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/fiJA5WhgigU\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\r\n\r\n<p>Valuing a stock involves assuming that its growth rate will slow down to a long-term rate comparable to the economy. The value projected at the end of the high-growth stages based on the long-term growth rate is known as the <em><strong>terminal value<\/strong><\/em> of the stock (or continuing value).<\/p>\r\n<p>The terminal value may be calculated :<\/p>\r\n<ol style=\"list-style-type: lower-roman;\">\r\n\t<li>Using the Gordon growth model.<\/li>\r\n\t<li>Applying a multiple, e.g., P\/E to an estimated fundamental, e.g., EPS at the terminal date.<\/li>\r\n<\/ol>\r\n<h4>Example: Estimating Terminal Value using the Gordon Growth Model and a P\/E Multiple<\/h4>\r\n<p>Consider the following information:<\/p>\r\n<ul>\r\n\t<li>Recently paid annual dividend = $0.40.<\/li>\r\n\t<li>Dividend growth rate = 12% for the next 5 years.<\/li>\r\n\t<li>The growth rate will stabilize to a long-term rate of 4%.<\/li>\r\n\t<li>Trailing P\/E ratio at the end of the initial high-growth period = 6.<\/li>\r\n\t<li>Retention ratio = 25%.<\/li>\r\n\t<li>Required rate of return = 12%.<\/li>\r\n<\/ul>\r\n<p>Using the Gordon growth model, the terminal value is calculated as:<\/p>\r\n<p>$$\\begin{align*}\\text{Year 5 dividends}&amp;=0.40(1.12)^{5}\\\\&amp;=0.70\\\\ \\\\ \\text{Terminal value}&amp;=\\frac{0.70(1.04)}{12\\%-4\\%}\\\\&amp;=\\frac{0.728}{0.08}\\\\&amp;=9.16\\end{align*}$$<\/p>\r\n<p>Using a P\/E multiple, the terminal value is calculated as:<\/p>\r\n<p>$$\\begin{align*}\\text{Year 5 dividends}&amp;=0.70\\\\ \\\\ \\text{Year 5 EPS}&amp;=\\frac{0.70}{0.75}=0.9333\\end{align*}$$<\/p>\r\n<p>Applying the trailing P\/E of 6 based on year 5 EPS of 2.8, the terminal value is:<\/p>\r\n<p>$$\\text{V}_{0}=0.9333\\times6=5.6$$<\/p>\r\n<blockquote>\r\n<h2>Question<\/h2>\r\n<p>A company&#8217;s current EPS of $2.50 is expected to grow at 12% for 8 years. After that, it will decline to a long-term rate of 4%. If the trailing P\/E at the end of the high growth stage is 9, the terminal value is <em>closest<\/em> to:<\/p>\r\n<ol style=\"list-style-type: upper-alpha;\">\r\n\t<li>$22.55.<\/li>\r\n\t<li>$57.80.<\/li>\r\n\t<li>$55.70.<\/li>\r\n<\/ol>\r\n<h4>\u00a0Solution<\/h4>\r\n<p><strong>The correct answer is C.<\/strong><\/p>\r\n<p>$$\\begin{align*}\\text{EPS}_{8}&amp;=2.50(1.12)^{8}=6.19\\\\ \\\\ \\text{Terminal value}&amp;=6.19\\times9=55.71\\end{align*}$$<\/p>\r\n<\/blockquote>\r\n<p>Reading 23: Discounted Dividend Valuation<\/p>\r\n<p><em>LOS 23 (k) D<\/em><em>escribe the terminal value and explain alternative approaches to determining the terminal value in a DDM.<\/em><\/p>\r\n","protected":false},"excerpt":{"rendered":"<p>Valuing a stock involves assuming that its growth rate will slow down to a long-term rate comparable to the economy. The value projected at the end of the high-growth stages based on the long-term growth rate is known as the&#8230;<\/p>\n","protected":false},"author":5,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[102,401],"tags":[216,402,440,451],"class_list":["post-17824","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","category-equity-valuation","tag-cfa-level-2","tag-equity-valuation","tag-reading-27-discounted-dividend-valuation","tag-terminal-value","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.4 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Terminal Value - CFA, FRM, and Actuarial Exams Study Notes<\/title>\n<meta name=\"description\" content=\"Valuing a stock involves assuming that its growth rate will slow down to a long-term rate comparable to the economy.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/terminal-value\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Terminal Value - 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