Which formula is used to calculate the present value of terminal value?

The present value of terminal value, often used in financial modeling to estimate the value of a business or project beyond a projection period, is calculated using the formula that incorporates the future value of the terminal value adjusted for the discount rate over time. The correct formula reflects this relationship by dividing the terminal value by the factor that encompasses the compounding effect of the discount rate over the specific number of periods until the present time.

In the correct formula, the terminal value is divided by ((1 + r)^N), where (r) represents the discount rate and (N) signifies the number of periods into the future that the terminal value is projected. This accounts for the time value of money, allowing investors to assess how much future cash flows are worth in present terms.

This calculation is crucial because it ensures that the terminal value, which usually represents a significant portion of the total value in discounted cash flow models, accurately reflects its value today, considering the diminishing value of cash flows received in the future.