Lesson 3 of 6
Two stages and a terminal
The model built once, in the open, with every discounted year on the page and the terminal value stated as the share of the answer it actually is.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
Who writes thisEditorial processLinkedIn (opens in a new tab)X (opens in a new tab)
In one minute
- Five explicit years and a terminal value, with every discount factor on the page so the arithmetic can be checked by hand.
- The terminal value is 68.6 percent of this model's answer, which is the single most important thing about it.
- The model produces 112.87 dollars a share, and that figure is an output of three choices rather than a fact about the company.
Everything is located, so the arithmetic is short. It is written out in full here rather than described, because a model a reader cannot check by hand is not a model they should use.
Where the value comes from
- Explicit years 1 to 5 · 31.4% of the total3,541$m
- Terminal value · 68.6% of the total7,721$m
The explicit years
Starting free cash flow of 883.3 million dollars, grown at 2 percent, discounted at 10 percent.
| Year | Free cash flow, $m | Discount factor | Present value, $m |
|---|---|---|---|
| 1 | 901.0 | 1.100 | 819.0 |
| 2 | 919.0 | 1.210 | 759.5 |
| 3 | 937.4 | 1.331 | 704.2 |
| 4 | 956.1 | 1.464 | 653.0 |
| 5 | 975.2 | 1.611 | 605.5 |
| Total | 3,541.3 |
Every line can be checked with a calculator. The discount factor in year three is 1.10 cubed, and 937.4 divided by 1.331 is 704.2.
The terminal value
Year six free cash flow is 975.2 grown once more at 2 percent, which is 994.7 million dollars. Divided by the required return less the terminal growth rate, 0.10 less 0.02, gives 12,434.1 million. Discounted back five years at 1.611 that is 7,720.6 million.
The total, and what it is
Three thousand five hundred and forty-one million plus seven thousand seven hundred and twenty-one million is 11,261.9 million dollars. Over 99,779 thousand diluted shares that is 112.87 dollars a share.
That figure is an output of three choices. Change the required return to 11 percent and it becomes 100.33. Change it to 9 percent and it becomes 128.99. The next lesson is about exactly that.
What is not in it
No net cash adjustment. Free cash flow here is operating cash flow less capital expenditure, and at this filer interest paid already sits inside operating cash flow, so the stream is after debt service. Adding cash on top would be a judgement, and this model does not make it. A reader who would make it should say so, and their value will be higher.
No consideration of the maturity schedule, the inventory carrying value, or anything else the applied cyclical course established. A discounted cash flow values a stream. Everything else belongs in the conditions document, which is what the previous capstone produced.
Check yourself
What is the present value of year three's cash flow?
- 937.4 million, the cash flow itself
- 704.2 million, which is 937.4 divided by 1.10 cubed
- 605.5 million
Show the answer
Answer: B.
605.5 million is year five. Every discount factor in the table is the required return compounded for that many years.What share of this model's answer is the terminal value?
- About a third
- 68.6 percent
- All of it, since the explicit years are small
Show the answer
Answer: B.
The explicit years contribute 3,541.3 million and the terminal value 7,720.6 million. Any discussion that spends its time on the explicit years is discussing the third that matters least.Why is no net cash added to the value?
- Because the company holds no cash
- Because the stream is already after debt service, so adding cash on top would be a judgement this model does not make
- Because cash is not a filed figure
Show the answer
Answer: B.
At this filer interest paid sits inside operating cash flow. A reader who would add net cash should say so, and their value will be higher.Sources
- Toll Brothers, Inc., annual reports on Form 10-K for fiscal years 2017 through 2025, for operating cash flow, capital expenditure and diluted share count; fiscal 2025 accession 0000794170-25-000112, filed 19 December 2025.
What this leaves out
- Every figure in this model except the free cash flow history and the share count is a choice. The required return, the explicit growth rate and the terminal growth rate were chosen to build one worked example and are not recommendations.
- The starting figure is a nine-year mean over a window containing no contraction of the kind this industry has experienced. A model built on a window that contained one would start lower.
- A perpetual growth assumption is an assumption about forever. It carries 68.6 percent of this answer and nothing verifies it.
- Nothing here is a view on Toll Brothers or on any security, and the figure produced is not a target price.