Sometimes there are terminal values in equity valuation. Sometimes there are not. Trying to separate.
Gordon Growth Model and H Model do not have terminal values. However regular 2 stage and 3 stage DDM do have terminal values and adding up PVs of each year of dividends. Which of the free cash flow DCFs have terminals versus not?
GGM is a terminal value in, and of, itself. The terminal value is built into the H-model (notice how you divide by (r-g)…)
You could do the very long, drawn out, version of the H-model to see the terminal value calculation at the end, but, just know the formula and understand the terminal value is built into the formula.
sorry to not provide an explanation to your question (primarily because there really isn’t one). But would you look… hit it on the head. Its about understanding what the formulas are, understanding perpetuity theory, and so on.
ok thank you. clearly i have a lot of work to do in a small amount of time.
I thought about this a bit more and maybe can give you some sort of guidance since there is only 5 days left and this is not something you truly grasp an understanding of quick.
I would look at the denominator in a valuation problem. If you get a (r-g) or just ® then this is a perpetuity so would be considered terminal value. Whereas if the denominator is ((1+r)^t) then this is just discounting a single cash flow, so no terminal value is implied.
To better understand what I am saying, lets use an example with some numbers. Let use 100 as your cash flow.
If you use r-g, then the number should probably be in the range of 5-10% right? so 100/7% = about 1425…This is a big number, so common sense would tell you it is a value of a firm, hence a terminal value is in the formula.
Now if we use same rate of 7% and have a denominator that is (1+.07)^2 which equals about 1.14 you would then use the same 100 cash flow to get 100/1.14 = about 87 which is obviously not a firm value, because its smaller than the original 100 cash flow and thus a terminal value is missing if you are trying to get a value of an entity.
Hope that helps, strange concept to explain imo.