Terminal value of a security is defined as the present value at a future point in time of the future cash flows when stable growth rate is expected forever. In simpler words, terminal value is the evaluation of what an investment will be valued in future. The calculation of terminal value is very simple. By using a very simple formula given in this article, you will be able to easily calculate the value of the stock or share for a specific duration, rather than calculating it yearly. Read more to know about how to calculate terminal value.
Steps for calculation:
- Determine the interest rate of the investment, you have made. For example, let us take an interest rate of 5% annually. It should be converted into decimal. Here, 5% would be converted into 0.05.
- Add 1 to the interest rate. As per our example, here, 1 would be added to 0.05, making it 1.05. Here, it will be called as ‘i’ standing for interest.
- Find out the duration of the investment. Let us assume that we are computing the terminal value at 10 years in future. Here it will be called as ‘y’ standing for years.
- Now ‘i’ should be calculated to the ‘y’th power. As per our example, i = 1.05 &
y = 10.
Therefore, 1.0510 ≈ 1.628. This will be called as ‘A’.
- The principal investment will be multiplied A times. For example, let us assume that the investment is of Rs. 1,000 at 5% annual interest rate for 10 yrs. Now multiply the investment that is Rs 1000 to A that is 1.628. It will give a sum of Rs 1, 628.89.
- This final result is the terminal value of the investment you have made.
Tips
- The terminal value allows the inclusion of the value of future cash flows. It is normally used in multi stage discounted cash flow analysis.
- The exact future situation of the investment cannot be identified for sure.
- The terminal value is an estimate only, which is almost accurate and used widely.
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