Terminal Growth Rate Definition:
The terminal growth rate is the perpetual compound annual rate at which a company’s cash flow is assumed to grow after the discrete forecasting period.
It is a critical input in the discounted cash flow (DCF) model used to estimate the present value of a company.
Usage in DCF Analysis:
After forecasting free cash flows for a specific period, typically 5-10 years, a terminal value is calculated to capture the value of the business beyond the forecast period.
The terminal growth rate is applied to the final year’s cash flow to estimate this terminal value.
Importance of Terminal Growth Rate:
It represents the expected long-term growth rate of the company and significantly impacts the valuation.
Assumptions about this rate must be reasonable and aligned with long-term economic growth projections.
References:
The terminal growth rate is a well-established concept in financial analysis and valuation, particularly within the context of the DCF model, as outlined in various CFA Institute materials on valuation and financial analysis.
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