DCF - How do you come up with your Terminal Growth Rate?
I know how to find the terminal value, this question is about estimating the terminal growth rate...
I have used the search bar and can't find a definitive answer.
I have been told that it should be GDP growth rate +/- your estimate. Anyone else ever hears this? I know that it should be somewhere between 1-3%.
By the way, I am using this for a DCF model of Procter and Gamble...Thanks, guys!
How to Determine Terminal Growth Rate
The terminal growth rate is a percentage that represents the expected growth rate of a firm's free cash flow. The percentage is used beyond the end of a forecast period until perpetuity. The percentage is usually fixed for that period. There are three different percentage ranges used. The most common being the mature range.
- Initial growth rate
- The company is seizing market share and is experiencing high revenue growth. Growth rate 10% or greater
- Slowing growth rate
- Company is somewhat established and gains competitors. Some resources diverted to keeping current market share. Growth rate between 5% and 8%
- Mature growth rate
- Company is established and allocates a substantial amount of it's resources to protecting its market share, Positive growth rates at this stage mirror the historical inflation rate, between 2% and 3%. Historical GDP growth can be used alternatively which is between 4% and 5%.
from certified risk management professional @SSits"
terminal growth rate is usually the long-term growth rate. If your industry is in the mature state (not growth, not decline) and your company's market share will remain stable, then the assumption is that long-term growth rate = GDP growth rate.
As a sense check, you can look at the multiples of similar companies in mature markets and back out their implied long-term growth rate using the Gordon growth model concept, although it gets a little conceptually muddy.
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GDP growth rate can be a good starting point. Personally, I look at the patterns and trends in the industry, as well as key growth drivers for the specific company. For example, I was recently looking at a large mature food retailer and for the term. growth rate I used estimates for the population growth rate and food inflation.
For P&G, you could break it down by business segments and estimate individual growth rates.
You use the WACC to discount the TV value. GDP growth is sometimes used as 'g' in the following equation: TV = FCF_n * (1+g) / r-g where r = WACC, n = period n
terminal growth rate is usually the long term growth rate. If your industry is in mature state (not growth, not decline) and your company's market share will remain stable, then the assumption is that long term growth rate = GDP growth rate.
As a sense check, you can look at the multiples of similar companies in mature markets and back out their implied long term growth rate using the Gordon growth model concept, although it gets a little conceptually muddy.
Inflation is fine. Otherwise, if you had g > inflation rate, you will assume that one day your company will have revenues > GDP.
Echoing the above posters you can do a weighted inflation/GDP growth for the firm depending on the current and future geography mix of their operations.
For mature businesses, usually the estimate GDP growth rate.
Goal seeked to whatever gives you the final valuation number you want...
In all seriousness, 1-2% is reasonable. GDP growth rate would only work for mature economies i.e. ~2-3% GDP growth.
I've always been curious, why wouldn't g be the nominal gdp growth rate? If you only increase it at inflation, you're assuming you lose market share because gdp rises at inflation + the real growth rate. Similarly if you increase it at only the real gdp growth rate, you are missing out on the nominal growth from inflation.
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