Which method is commonly used to estimate terminal value in a DCF when cash flows are assumed to grow at a stable rate forever?

Which method is commonly used to estimate terminal value in a DCF when cash flows are assumed to grow at a stable rate forever?

• A. Perpetuity growth
• B. Discounting back to present value
• C. Using exit multiple
• D. Sum of forecast period cash flows

Answer: (A)

When you expect cash flows to grow at a constant rate forever, you estimate terminal value using a perpetuity with growth (the Gordon Growth Model). This approach captures the infinite series of growing cash flows with a simple formula: TV = FCF_{n+1} / (r - g). If you start from the last forecast year, it’s TV = FCF_n × (1 + g) / (r − g). It’s important that the discount rate r is greater than the perpetual growth rate g, so the value remains finite. This method directly reflects the steady, perpetual growth assumption and is the standard way to estimate the terminal value under that scenario. Alternatives exist (like using an exit multiple or summing only the explicit forecast), but they don’t embody the constant perpetual growth idea.

When you expect cash flows to grow at a constant rate forever, you estimate terminal value using a perpetuity with growth (the Gordon Growth Model). This approach captures the infinite series of growing cash flows with a simple formula: TV = FCF_{n+1} / (r - g). If you start from the last forecast year, it’s TV = FCF_n × (1 + g) / (r − g). It’s important that the discount rate r is greater than the perpetual growth rate g, so the value remains finite. This method directly reflects the steady, perpetual growth assumption and is the standard way to estimate the terminal value under that scenario. Alternatives exist (like using an exit multiple or summing only the explicit forecast), but they don’t embody the constant perpetual growth idea.