Damodaran's terminal value calculations don't make sense.
Hi all. I know a lot smart people in finance who speak highly of Aswath Damodaran, so I've been studying some of his models to understand how he approaches valuation. In the course of reviewing his "simple" dcf model (linked here), I noticed something odd.
If you increase his perpetual growth rate assumption (cell M2 on the "Valuation Output" sheet), this produces less free cash flow and a lower valuation. Put differently, faster growing companies are valued less (all else equal).
This just seems incredibly unintuitive, and I can't wrap my head around it. I understand that a faster growing company requires more CAPEX, and therefore, revenue growth shouldn't increase linearly with free cash flow growth. However, revenue growth should still produce more free cash flow.
What am I not understanding? Is this just a quirky academic assumption that I shouldn't get hung up on?
Is the ROIC lower than the WACC? If you increase the growth rate in that scenario, then you will decrease the terminal value.
The value increases if you increase the growth in M2? The reason why you may have gotten a weird answer is because you set terminal growth at >6%, which is higher than the terminal cost of capital. The formula is divided on cost of capital - growth, so if perpetual growth is higher than the cost of capital you get a negative number. However, you would never set terminal value as high as 6%. Another approach would be to use exit multiple terminal value, which I think practitioners prefer.
OP here. Figured it out. Unsurprisingly, it was a dumb mistake on my part--misread a couple of the cells.
When growth increases, his terminal year cash flow decreases but not his terminal value, which makes sense. SB'ed you guys in the comments
a lot of smart people speak highly of Damodaran
Lmao no bro, we all just kinda piggy back off of each other. He's a definitely a valuation genius but we don't use him because he's a genius, we use him mainly because a few guys started using him and then everyone else started using him just because it's the "thing to do."
Suffice it to say, Damodaran is an intelligent man, but that is not why his theories are applied by those who use this website.
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