Certified Valuation Analyst (CVA) Practice Exam

What does "terminal value" refer to in investment finance?

1. The initial investment value

2. The capitalized value of expected cash flow after the projected growth rate stabilizes

3. The projected cash flow for the first year

4. The final liquidation value of an asset

The correct answer is: The capitalized value of expected cash flow after the projected growth rate stabilizes

The term "terminal value" refers to the capitalized value of expected cash flow after the projected growth rate stabilizes, which is crucial in the discounted cash flow (DCF) valuation method. This value represents the present worth of all future cash flows expected to be generated by an investment beyond a specific forecast period, typically when the investment is expected to grow at a stable rate indefinitely. In valuation practice, terminal value is particularly important because it can account for a significant portion of the total valuation of a business or an investment. Generally, after projecting the cash flows for a certain number of years (often 5 to 10), analysts need a way to estimate the value of the cash flows that will follow, which the terminal value provides. This helps assess the long-term value of the investment beyond the explicit forecast period. The other answer choices do not accurately define terminal value. For instance, the initial investment value pertains to the starting capital required, the projected cash flow for the first year focuses only on short-term projections, and the final liquidation value pertains to what can be recovered if an asset is sold off, which is not relevant to the concept of terminal value aiming at future cash flows.