How to Calculate Terminal Growth Rate

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Understanding and Calculating the Terminal Growth Rate

The terminal growth rate (TGR) is a crucial concept in financial modeling, particularly when valuing a company using the Discounted Cash Flow (DCF) method. It represents the constant growth rate at which a company's free cash flows are assumed to grow indefinitely beyond the explicit forecast period. In simpler terms, it's the rate at which the business is expected to expand forever.

Why is the Terminal Growth Rate Important?

The terminal value often constitutes a significant portion of a company's total valuation. A well-reasoned terminal growth rate is essential for arriving at a realistic and defensible valuation. If the assumed TGR is too high, it can inflate the valuation. Conversely, a TGR that is too low might undervalue the company.

Key Considerations for Terminal Growth Rate

  • Economic Growth: The TGR should generally not exceed the long-term expected growth rate of the overall economy or the industry in which the company operates. A company cannot grow faster than its market indefinitely.
  • Inflation: The TGR should typically be in line with or slightly above the expected long-term inflation rate.
  • Company Maturity: Mature, established companies with dominant market positions are more likely to sustain a modest growth rate than young, rapidly expanding ones.
  • Competitive Landscape: Intense competition can limit a company's ability to grow at a high rate.

Methods for Calculating Terminal Growth Rate

The most common method for calculating terminal value and, by extension, the terminal growth rate is the Gordon Growth Model (also known as the Dividend Discount Model for terminal value). The formula for terminal value using the Gordon Growth Model is:

Terminal Value = FCFFn+1 / (WACC – g)

Where:

  • FCFFn+1 is the Free Cash Flow to Firm in the year after the explicit forecast period (n).
  • WACC is the Weighted Average Cost of Capital.
  • g is the terminal growth rate.

This calculator helps you estimate the terminal growth rate based on these inputs.

Terminal Growth Rate Calculator

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Estimated Terminal Growth Rate: N/A%

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