Perpetuity Growth Method

A DCF only forecasts cash flows explicitly for 5-10 years, but a healthy company keeps generating cash long after that. The terminal value captures everything beyond the forecast, and it typically accounts for 60-80% of the total enterprise value in a DCF. The perpetuity growth method is favored when you want a valuation grounded in fundamentals rather than current market sentiment: it ties terminal value to the company's long-run growth and your WACC, not to whatever multiple comps happen to trade at today. Bankers often run it alongside the exit-multiple method and cross-check the two so neither implies an unreasonable result.

You take the unlevered free cash flow in the final forecast year, grow it one period at the perpetuity growth rate (g), then capitalize it by dividing by (WACC - g). That gives you the terminal value as of the end of the final forecast year. You then discount that terminal value back to the present using the same WACC and the final-year discount factor. Critically, WACC must be greater than g or the formula breaks (a negative or infinite denominator), which is also why g must stay below the long-run economy growth rate.

The exit-multiple method instead applies a market multiple (e.g., EV/EBITDA) to the final-year metric. Exit multiple is more common in practice because it grounds terminal value in observable market data and is easy to defend in front of clients. The perpetuity growth method is preferred when no clean comp set exists or when you want a market-independent view. Best practice: compute terminal value both ways and back into the implied figure from the other method. If your perpetuity growth assumptions imply a 25x EBITDA exit multiple, your growth rate is too high; if your exit multiple implies a 5% perpetuity growth rate, your multiple is too aggressive.

The result is hyper-sensitive to the two inputs: a 50 bps change in either WACC or g can swing terminal value by 10%+, which is why analysts always present a sensitivity table. The model also assumes the company reaches a stable steady state by the final year (margins normalized, capex roughly equal to depreciation, working capital neutral) — if your final forecast year still shows high growth or heavy reinvestment, the perpetuity is mis-anchored. Finally, g must be defensible: anything above long-run nominal GDP (~2-3% in developed markets) implies the company eventually becomes larger than the entire economy.