Why is it important to test sensitivity around WACC and perpetual growth rate in PE DCF models?

• A. Only rely on one scenario
• B. Because small changes can drastically affect terminal value and IRR; helps gauge risk
• C. Terminal value is unaffected by WACC
• D. WACC and growth rate have no impact

Answer: (B)

Sensitivity around WACC and perpetual growth rate matters because in a PE DCF, the terminal value often drives most of the investment’s value and it is highly sensitive to these inputs. The terminal value is typically calculated as free cash flow in the next period divided by (WACC minus the perpetual growth rate). Because the denominator is WACC minus g, small changes in either WACC or g can cause large swings in terminal value, which in turn swing the IRR and overall equity value. This is why running sensitivity analyses around those two inputs is essential: it reveals how robust the investment case is, shows the potential range of exit values, and helps gauge risk and inform pricing, financing, and performance expectations. Relying on a single scenario misses how outcomes could vary; the terminal value is not shielded from these inputs, and the idea that WACC and growth have no impact is incorrect.