Question

The present value, today, of the terminal (perpetuity) value equity cash flow that begins in 7 years is $6,700,000 assuming a cost of equity equal to 8%. The year 7 free cash flow (beginning of the growing perpetuity) is $550,000. What is the growth rate required for the continuation value (terminal value perpetuity) term?

Answer 1

2.83%

Step-by-step explanation:

P0 = $6,700,000

Cost of equity Ke = 8%

So, value of this perpetuity 6 years form now is P6 = P0*(1+Ke)^6

= $6,700,000*(1.08)^6

= $6,700,000*1.58687432294

= $10632057.96

Free cash flow at year 7 (FCF7) = $550,000

So, using constant growth model, g = Ke - FCF7 / P6

g = 0.08 - 550000/10632057.96

g = 0.08 - 0.05173034

g = 0.02826966

g = 2.83%

Thus, the growth rate required for the continuation value (terminal value perpetuity) term is 2.83%.