"Walk me through how you'd calculate Terminal Value" is a near-universal DCF interview question, and it rewards candidates who can explain not just the formula but why each input matters. Below is the four-step method, with a worked example you can follow line by line.
Step 1: Identify the Final Year's Free Cash Flow
The Gordon Growth formula starts with the free cash flow from the last year of your explicit forecast — not an average of all the forecast years, and not a rounded or normalized figure. It has to be the actual "steady-state" cash flow the business is projected to generate in that final year, since everything after it is assumed to grow from that base. Suppose the explicit forecast runs five years and Year 5 free cash flow comes in at $50.0m.
Step 2: Choose a Defensible Perpetuity Growth Rate
Next, pick a growth rate (g) the business can plausibly sustain forever. This is almost always a modest figure — typically close to long-run inflation or GDP growth — because no company can outgrow the broader economy indefinitely. For this example, assume a perpetuity growth rate of 2.5% (0.025).
Step 3: Apply the Gordon Growth Formula
Terminal Value = FCF(final year) × (1 + g) / (WACC − g), where WACC is the company's discount rate. With a WACC of 9.0% (0.09): Terminal Value = $50.0m × (1 + 0.025) / (0.09 − 0.025) = $50.0m × 1.025 / 0.065 = $788.5m. This is the value of the business as of the end of Year 5, not today — which is why it still needs to be discounted.
Step 4: Discount the Terminal Value Back to Present Value
PV of Terminal Value = Terminal Value / (1 + WACC)^n, where n is the number of years between today and the final forecast year. With n = 5: (1 + 0.09)^5 = 1.5386, so PV of Terminal Value = $788.5m / 1.5386 = $512.4m. Adding this to the present value of the explicit-period cash flows (say, $185.0m) gives an Enterprise Value of $697.4m — meaning Terminal Value alone accounts for roughly 73.5% of the total.
Common Follow-Up Questions
Interviewers rarely stop at the number. Be ready to explain what happens to Terminal Value if the growth rate or WACC shifts by even half a percentage point (the swing is usually larger than candidates expect), why the formula uses next year's cash flow — FCF × (1 + g) — rather than the final year's figure as-is, and how you'd sanity-check the result using an implied exit multiple against comparable companies.
Work Through the Full Case
For the complete version of this walkthrough — including the given data table, the formula reference for each step, and the full model answer — see Terminal Value: Gordon Growth. Since WACC is the discount rate this formula depends on, it also helps to review how to calculate WACC before working through this case.