Practice Problem – Growth Rate and Terminal Value

Practice Question

Cases in Finance
Valuation Tools
Growth Rate and Terminal Value
Short Answer

When calculating the terminal value in a DCF analysis, which formula is typically used for a growing perpetuity?

Answer +
B
Explanation +

The terminal value in a DCF analysis often assumes cash flows will grow at a constant rate indefinitely. The formula for a growing perpetuity is:

Terminal Value = Final Year Cash Flow × (1 + g) / (r – g)

where:

  • g = constant growth rate
  • r = discount rate
  • Final Year Cash Flow is the projected cash flow in the last forecast year
This formula calculates the present value of future cash flows growing at a constant rate beyond the projection period.