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Terminal Value - Meaning, Formula, Example, Calculation in Excel - YouTube
Channel: WallStreetMojo
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hello everyone hi welcome to the channel
of WallStreetmojo friends today we are
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going to learn a topic that is called
terminal value now terminal value has a
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significant level of importance when you
are evaluating the DCF method for valued
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value should valuating any business for
valuing any share or so on and
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so forth so why it is so important now
as you can see from the diagram there is
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FCFF 1 that is free cash flow for first
year second year third fourth and fifth
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and finally this fifth year from the
fifth and onwards here this fifth year's
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number will be divided by one plus the
weighted average cost of capital divided
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by the n so once you do that you will
get your total this you will get your
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total terminal value so it's it's the
present value of the explicit FCFF and
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the present value of the terminal from
here onwards so this is going to be till
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infinity so that will be your total
enterprise value from the diagram itself
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it's little bit understandable but let's
get into the nitty-gritty of the same
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what is terminal value first let's
understand this see terminal values the
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value of the company is expected free
cash flow beyond the period of the
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explicit projected financial model now
let's try and calculate the terminal
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value and understand exactly how the
whole concept works see the dominant
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value valuation value calculation is a
key requirement of the discounted cash
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flow so it is first it is very difficult
to project the company's financial
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statement okay and showing how they
would develop over longer period of time
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second the confidence level of the
financial statement projection
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diminishes exponentially for years which
are way farther from today so just write
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the confidence level over here Third
Point is something like this that is the
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macroeconomics condition affecting the
business and the country may change the
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structure I mean we may change the thing
structurally therefore we simplify and
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you certain average
assumption to find the value of
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deform beyond the forecasted period
which is known as the terminal value now
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what are these steps that are involved
in calculating the dominant value see in
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this section briefing about the overall
approach to perform the DCF or DC
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evaluation of any company especially the
step 3 where we calculated the terminal
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value of the form the step 1 that is the
step 1 is something like this we have to
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create the infra the infrastructure okay
and and prepare the blank excel sheet
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with separate income statement balance
sheet cash flow statement pop up all the
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historical financial statement and so on
and so forth perform some ratio analysis
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and all so create the infrastructure
first then the step 2 part is you know
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you need to project the financial
statement and the FCFF okay now the
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step 3 which is the most important part
step 3 is find the fair value or the
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fair share price of the form by
discounting the FCFF
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and the terminal value this is where we
are supposed to work so over here
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calculate you your FCFF for let's say
5 years okay and apply some suitable
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WACC on the capital structure
calculation calculate the present value
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of the explicit period of FCFF and
finally calculate the present value
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finally calculate the value of the
company now this is the period beyond
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the explicit period then you will
calculate your enterprise value which is
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your present value of the explicit focus
period that is the explicit
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period of FCFF + the present value of
the terminal value right then after that
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find the equity okay find the equity of
the form value of the form after
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deducting any debt if any okay and
divide this whole thing divide this
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whole thing by the divide the equity
value of the form by the total number of
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shares to arrive at the intrinsic value
of the shares so this is how you find
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and and then you can recommend by call
or cell call right so this is exactly
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how things work now what is the terminal
value formula say an important
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assumption here is going to be going
concern C or going on some of the
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company C in other words the company
will not stop its business operation
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after a few years however it will
continue to do business forever so the
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value of the form that is we called as
enterprise value is basically the
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present value of all the future you can
see free cash flow to the firm now we
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can represent this as terminal value is
equal to FCFF / 1 + WACC and that is
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going to be raised to n right now the
three types of formula for calculating
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terminal value of the form the force to
approach assume that the company will
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exists this are the first to approach
that will did that say that they exist
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on the going concern basis and at the
time of the estimation of TV the third
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approach okay the third approach assumes
that the company is taken over by the
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larger corporate thereby paying the
acquisition price so let's look at this
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approaches in detail the first one is
the perpetuity growth okay or it's
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called Gordon's growth model this method
has something a formula you know this
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weather is preferred formula to
calculate the terminal value of
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the method assumes that the growth of
the company will continue at the stable
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growth rate and return on the capital
will be more than the cost of the
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capital that is our is going to be
greater than the WACC you can say and we
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discount the free cash flow to the form
beyond the projected years and then we
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find the terminal value so the terminal
value is going to be is equal to you can
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say the FCFF for let's say the sixth
year divided by 1 + WACC ok the one plus
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WACC is going to remain the same over
here the only the number is going to
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change this is FCFF 7 then 8 and then 9
and it will go till infinity right so
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this using the school method you can
finally go with I mean you don't want to
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work out this right so you can calculate
as simple as that
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TV is equal to your FCFF for your sixth
year right divided by your WACC less your
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growth rate once you do that you have
your answer the second method of
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calculation is or no growth policy that
is perpetuate a model so this formula
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assumes that the growth rate is
completely zero and this assumption
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implies that the return on the new
investment is equal to the cost of the
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capital so the terminal value will be is
equal to your FCFF 6 divided by your
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WACC the third method is the exit
multiple method right in this scenario
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the formula uses the underlying
assumption that the market multiple
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basis is a fair approach to value of
businesses and a value is typically
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determined as a multiple offer you can
say EBIT or EBITDA okay and for
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cyclically business instead of EBITDA or EBIT amount at the end of the year we
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use an average of the EBIT and the
EBITDA over the course of the cycle
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so for example if the metal and the
mining sector is trading at let's say 8
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times EV/EBITDA okay the by
EV/EBITDA then the TV of the company employed
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using this method is going to
8x of the EBITDA of the company thank
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you everyone
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