Question

How can FCF in the terminal year of a project’s life differ from FCF in the other years? Provide an example.

Answer 1

When the free cash flow reaches the terminal year it is assumed that the FCF will grow at a required growth rate for perpetuity. In addition to that in the terminal year, actual sales which involve cash flows are considered, recovery of working capital is also found in the final year of the project. An example of winding up of business means that the operations it had over a period of time have to be looked into along with the selling of the assets to meet the liabilities of the firm. In terms of mathematical expression,

FCF discounted by the required rate of return for any normal period would involve, FCF/ (1+r) while in the final year the perpetuity needs to be considered which involves, FCF/ (Required Return –Growth)* 1/ (required rate of return).