Quick question. If you are trying to value a company, will you get the same valuation using both of these methods, or will the number be different? Assume we know the company will grow at 5% forever.
Method 1:
Project FCF for Years 1-5 and discount to present + Terminal Value
Method 2:
Growth in perpetuity - FCF year 1/ discount rate-growth rate
I get a higher number for method 1, but shouldn't they be the same?
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sounds like it should be the same.
check to make sure you did the year 5 to terminal value correctly, and discounted it back by the correct number of years.
What do you mean make sure it's discounted by the correct number of years? I'm just using (FCF in year 5 x 1.05)/discount rate - growth rate. Should I be discounting that?
yes, that perpetuity growth formula gives you the terminal value in year 5, which needs to then be discounted to present value @ t=0
that should fix your problem
Yep that worked thanks. But in order to get the right number, I have to use 5 as the exponent on the denominator when discounting the terminal value. Since the TV is derived from year 6 cash flow, why am I only discounting 5 years, not 6?
The TV is giving you the value of all cash flows from year 6 to infinity, at t=5, hence you discount 5 years back to t=0
it's just a basic perpetuity growth formula
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