Question

f we use the "growing perpetuity value" approach to calculate the terminal value, we

	A.	All of these answers are correct.
	B.	must assume that the terminal growth rate of free cash flows is less than the asset cost of capiptal.
	C.	must use the formula TV = FCFn/RA .
	D.	typically assume a relativley high terminal growth for free cash flows.

Answer 1

Solution.>

The correct answer is (B).

If we use the "growing perpetuity value" approach to calculate the terminal value, we must assume that the terminal growth rate of free cash flows is less than the asset cost of capital. Otherwise, the enterprise value would become negative which cannot be possible.

Option (C) is not correct because the correct formula is TV = FCFn(1+g)/(RA - g)

Option (D) is not correct because we typically assume a relatively low terminal growth for free cash flows because a company cannot keep growing at high growth rate forever.

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