What is the formula for the terminal value in the perpetuity growth method?

• A. TV = FCFn*(1+g)/(WACC - g)
• B. TV = FCFn*(1 - g)/(WACC + g)
• C. TV = FCFn*(1+g)/(WACC + g)
• D. TV = FCFn*(1+g) / (WACC - 2g)

Answer: (A)

The perpetuity growth method uses the Gordon growth model: the terminal value represents the value of a cash flow that grows at a constant rate forever, discounted at the required rate. The standard formula is TV at the end of year n = FCF1 / (WACC − g). Here FCF1 is the free cash flow next year. If you know the current year’s FCF, FCFn, then FCF1 = FCFn × (1 + g). Substituting gives TV_n = FCFn × (1 + g) / (WACC − g). This is exactly the expression shown.

The denominator uses the difference between the discount rate and the growth rate; adding them or using other forms would misstate the present value of a growing perpetuity. For example, using WACC + g would overstate the discount relative to growth, and using (1 − g) or (WACC − 2g) would not reflect the Gordon model’s assumption of a constant growth stream discounted at a constant rate. Keep in mind that the model requires g < WACC for a finite terminal value.