Which statement best describes terminal value estimation using perpetuity growth?

Which statement best describes terminal value estimation using perpetuity growth?

• A. They decline to zero after the forecast period.
• B. They grow at a fixed amount each year indefinitely.
• C. In terminal value estimation using perpetuity growth, cash flows grow at a constant rate forever.
• D. Terminal value is always equal to the last forecast period cash flow.

Answer: (C)

Terminal value estimation using perpetuity growth relies on treating the cash flows after the forecast period as a perpetually growing stream. It uses the Gordon Growth idea: the cash flows from next year onward grow at a constant rate g forever, so the value at the end of the forecast horizon is the next period cash flow divided by (r − g), where r is the discount rate. This captures the infinite series of future cash flows in a single amount, reflecting perpetual growth rather than a finite tail. It’s not a decline to zero, and it isn’t cash flows that rise by a fixed dollar amount each year (that would be arithmetic growth). It also isn’t simply the last forecast cash flow, since the terminal value incorporates all subsequent growth beyond the explicit forecast period. For example, if the next-year cash flow is 103, growth is 3%, and the discount rate is 8%, the terminal value would be 103 / (0.08 − 0.03) = 2060.

Terminal value estimation using perpetuity growth relies on treating the cash flows after the forecast period as a perpetually growing stream. It uses the Gordon Growth idea: the cash flows from next year onward grow at a constant rate g forever, so the value at the end of the forecast horizon is the next period cash flow divided by (r − g), where r is the discount rate. This captures the infinite series of future cash flows in a single amount, reflecting perpetual growth rather than a finite tail. It’s not a decline to zero, and it isn’t cash flows that rise by a fixed dollar amount each year (that would be arithmetic growth). It also isn’t simply the last forecast cash flow, since the terminal value incorporates all subsequent growth beyond the explicit forecast period. For example, if the next-year cash flow is 103, growth is 3%, and the discount rate is 8%, the terminal value would be 103 / (0.08 − 0.03) = 2060.