What is the relationship between the terminal value and the final year's FCF in the final cash flow calculation?

What is the relationship between the terminal value and the final year's FCF in the final cash flow calculation?

• A. Final cash flow is only terminal value
• B. Final cash flow equals final year's FCF
• C. Final cash flow equals terminal value plus final year's FCF
• D. They are unrelated

Answer: (C)

Terminal value captures all cash flows beyond the explicit forecast period. When you build a DCF, you project free cash flow for a finite horizon and then add a value that represents all future cash flows after that horizon. To get the cash flow figure for the final year you actually discount, you combine the last projected FCF with the terminal value. So the final cash flow equals the final year's FCF plus the terminal value. For example, if the last year’s FCF is 10 and the terminal value is 50, the final cash flow in that year is 60. This final amount, along with the preceding years’ cash flows and the terminal value, is discounted to present value to determine the enterprise value. The other options ignore either the ongoing value after the horizon or the fact that the terminal value represents more than just the next year’s cash flow.

Terminal value captures all cash flows beyond the explicit forecast period. When you build a DCF, you project free cash flow for a finite horizon and then add a value that represents all future cash flows after that horizon. To get the cash flow figure for the final year you actually discount, you combine the last projected FCF with the terminal value. So the final cash flow equals the final year's FCF plus the terminal value. For example, if the last year’s FCF is 10 and the terminal value is 50, the final cash flow in that year is 60. This final amount, along with the preceding years’ cash flows and the terminal value, is discounted to present value to determine the enterprise value. The other options ignore either the ongoing value after the horizon or the fact that the terminal value represents more than just the next year’s cash flow.