How to handle infinite growth in a FCF model
I am currently building a model for a firm that grows at a constant rate for 5 tears, then after that, is expected to grow at 1% for infinity. how do i model the sales and FCF for that?
Also, when building a model, does PPE grow at the same rate as sales? Would the same apply to LTD if no other information is provided?
Calculus baby!
For an infinite series of the form:
( 1+i )^n / ( 1+j )^n (for n=1 to infinity)
the series converges to 1 / ( j - i )
Real world example, if your discount rate is 8% and your cash flow of $1 is increasing at a rate of 4%, the present value of that cash flow is:
$1 / (8% - 4%) = $25
As for whether PP&E and long term debt grows with sales, I have no clue, but it probably depends on the company. Someone else may be able to offer a better explanation than me, though.
I love how superiors make us model FCF's for 10 years and more when they know that these models are barely accurate beyond three years if lucky
To add to this, where it gets spooky is how the discount rate concept and the multiple concept are intertwined. For example, applying a 20x multiple to a cash flow is equivalent to assuming that cash flow continues perpetually and applying a 5% discount rate to value it. Eerie...
You have to value it in perpetuity. Generally when you're looking at something in perpetuity, PPE won't necessarily grow at the same rate as sales. When a company has hit the steady state growth rate (perpetuity), it's fair to assume that capex will be close to D&A as it will be mostly maintenance capex vs growth capex.
^^
Value in perpetuity= CFlastyearofprojection / (Cost of Capital - infinite growth rate)
aka.
Terminal Value = FCFF (or FCFE) / (WACC - Gn)
Nulla voluptatem exercitationem et. Libero odio dignissimos et nostrum illum nam tempore. Cupiditate facilis voluptatem rerum quos tenetur cupiditate consequatur. Qui magni optio eos hic aut. Voluptatem omnis maxime eos eligendi sequi quisquam molestiae maiores. Ea quo maiores ut dolorem et quis. Qui numquam fuga rem voluptatem.
Architecto sit nostrum fuga sunt deserunt nihil. Eius placeat qui aut voluptatibus nemo ea eveniet explicabo. Dolorem aut assumenda molestiae quia reiciendis cupiditate.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...