Terminal value discounting
Hi guys, I have been doing some preps on the DCM, and can't rub my head around why TV is discounted a year less than the year we calculate it in. So the PV formula for terminal value in year 5 would be: FCF*(1+g)/(WACC-g) and then multiplied by discounted factor of 1/(1+wacc)^5. So in essence, first formula puts FCF to year 6 (by multiplying FCF with 1+g), then in my opinion that makes it TV in year 6 (once divided by (wacc-g)), but then that TV for year 6 is multiplied with discount factor for year 5. So, why would you multiply FCF by 1+g to get them to year 6, but only discount for 5 years? Any insight here much appreciated :) Thanks guys
The present value (i.e., the value in time period 0) of a growing perpetuity is calculated as:
PV = cash flow in year 1 / (discount rate - growth rate)
so if you want the value of the terminal value in year 5, you have to use the year 6 cash flow in the numerator. Once you have the result of the formula above, you discount back to the present using 5 years.
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