How to Calculate the Terminal Growth Rate

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Terminal Growth Rate & Value Calculator

Results

Estimated Terminal Value: $0.00

*Calculated using the Gordon Growth Method (Perpetuity Model).

function calculateTerminalValue() { var fcf = parseFloat(document.getElementById('fcf').value); var waccPercent = parseFloat(document.getElementById('wacc').value); var growthPercent = parseFloat(document.getElementById('growth').value); var resultArea = document.getElementById('result-area'); var output = document.getElementById('terminal-value-output'); if (isNaN(fcf) || isNaN(waccPercent) || isNaN(growthPercent)) { alert("Please enter valid numeric values for all fields."); return; } var wacc = waccPercent / 100; var growth = growthPercent / 100; if (growth >= wacc) { alert("Error: The Terminal Growth Rate must be lower than the Discount Rate (WACC). If growth exceeds the discount rate, the model results in an infinite or negative value."); return; } // Formula: TV = [FCF * (1 + g)] / (WACC – g) var terminalValue = (fcf * (1 + growth)) / (wacc – growth); output.innerText = "$" + terminalValue.toLocaleString(undefined, {minimumFractionDigits: 2, maximumFractionDigits: 2}); resultArea.style.display = "block"; }

How to Calculate the Terminal Growth Rate

The terminal growth rate is a critical assumption used in Discounted Cash Flow (DCF) analysis to estimate the value of a business beyond the explicit forecast period. Since companies are theoretically expected to operate forever, we use this rate to represent "perpetual" growth.

The Gordon Growth Method Formula

To calculate the Terminal Value based on a specific growth rate, analysts use the following formula:

Terminal Value = [Final Year FCF × (1 + g)] / (WACC – g)
  • Final Year FCF: The Free Cash Flow of the last year in your projection.
  • g: The Terminal Growth Rate.
  • WACC: The Weighted Average Cost of Capital (Discount Rate).

How to Choose a Terminal Growth Rate

Choosing the right rate is more of an art than a science, but there are strict logical boundaries you must follow:

  1. The GDP Constraint: A company cannot grow faster than the economy it operates in forever. If it did, it would eventually become larger than the entire global economy. Therefore, the terminal growth rate is typically capped at the long-term GDP growth rate (usually 2% to 3%).
  2. The Inflation Floor: Usually, the rate is set at least equal to the long-term inflation rate (around 2%).
  3. WACC Comparison: As seen in the calculator logic, the growth rate must be lower than your discount rate (WACC). If g > WACC, the math breaks down, resulting in an illogical negative valuation.

Realistic Example

Imagine a software company with a projected Free Cash Flow of $1,000,000 in Year 5. You estimate the WACC is 9% and the long-term terminal growth rate is 2.5% (aligned with projected inflation and GDP).

  • Step 1: Calculate the numerator: $1,000,000 × (1 + 0.025) = $1,025,000
  • Step 2: Calculate the denominator: 0.09 – 0.025 = 0.065
  • Step 3: Divide: $1,025,000 / 0.065 = $15,769,230.77

This $15.77 million represents the value of all cash flows from Year 6 into infinity, expressed in Year 5 dollars.

Common Mistakes to Avoid

Most errors in terminal growth calculations stem from being too optimistic. Setting a 5% or 6% terminal growth rate in a developed economy like the US or EU is generally considered aggressive and unrealistic by investors, as it implies the company will eventually consume the entire market.

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