FMP
Nov 2, 2023 9:50 AM - Parth Sanghvi
The terminal growth rate is a key component of the discounted cash flow (DCF) valuation model. It is the rate at which a company's free cash flow (FCF) is expected to grow in perpetuity beyond the explicit forecast period.
The terminal growth rate is typically estimated using a variety of methods, such as:
It is important to note that the terminal growth rate is a critical assumption in the DCF valuation model. A small change in the terminal growth rate can have a significant impact on the overall valuation of the company.
The terminal growth rate is used to calculate the terminal value of the company. The terminal value is the net present value of all future cash flows beyond the explicit forecast period. It is calculated as follows:
Terminal Value = FCF * (1 + g) / (WACC - g)
Where:
Once the terminal value has been calculated, it is discounted back to the present day using the WACC. This gives the present value of the terminal value, which is then added to the present value of the cash flows in the explicit forecast period to get the overall valuation of the company.
Consider a company with the following financial data:
The terminal value of the company would be calculated as follows:
Terminal Value = $100 million * (1 + 3%) / (10% - 3%) = $1,233 million
The present value of the terminal value would be calculated as follows:
Present Value of Terminal Value = $1,233 million / (1 + 10%) = $1,121 million
The overall valuation of the company would then be calculated as follows:
Overall Valuation = Present Value of Terminal Value + Present Value of Cash Flows in Explicit Forecast Period
The terminal growth rate is a key component of the DCF valuation model. It is important to carefully consider the assumptions made when estimating the terminal growth rate, as they can have a significant impact on the overall valuation of the company.
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