In most discounted cash flow (DCF) valuations, the terminal value accounts for well over half of the total value, which makes it the easiest number to get wrong and the easiest to manipulate.
In this session, Prof Damodaran sets out a few simple rules that keep the terminal value honest:
- The stable growth rate cannot exceed the growth rate of the economy (and is capped by the risk-free rate)
- Growth requires reinvestment, so stable-growth cash flows must reflect what it costs to grow
- Once a company reaches stable growth, its risk and cost of capital should look like those of a mature firm
A must-watch alongside the DCF Valuation Tutorial in this section, and a useful checklist for anyone reviewing a valuation report prepared by someone else.