Perpetual Growth Method

The method applies the same idea as the Gordon Growth Model to free cash flow. The terminal value equals the cash flow expected in the first year after the forecast period, divided by the discount rate minus the long-term growth rate.

For example, if the final forecast year's free cash flow is 10 million and it is expected to grow by 2% the following year to 10.2 million, with a discount rate of 9%, the terminal value is 10.2 million divided by 7%, about 146 million. This value, as at the end of the forecast period, is then discounted back to today.

The method is grounded in the company's own cash generation and long-term economic logic, rather than in market prices.

Its main weakness is sensitivity. Small changes in the growth rate or discount rate can significantly change the terminal value, and therefore the total valuation. The growth rate must be realistic, and it must be lower than the discount rate, or the formula breaks down. Analysts often cross-check the result against the exit multiple method.