Gordon Growth (Terminal Growth): Definition and Calculation
Gordon Growth (also called the perpetual growth model) is used to estimate a company's terminal value by assuming free cash flows grow at a constant perpetual rate.
Formula
Where g is the perpetual growth rate and r is the discount rate (WACC). Ensure g < r and choose conservative values (often slightly below long-term GDP/inflation).
Why it matters
- Terminal value often represents a large portion of DCF value; assumptions for g and r are critical.
- Choose conservative terminal growth rates to avoid overstating long-term prospects.
- Compare Gordon Growth to exit-multiple approaches (e.g., EV/EBITDA) as a sensitivity check.
Implementation notes
- Use the last projected FCF (or an average of final years) as the base for FinalYearFCF.
- Keep g conservative (often 1–3% for mature economies) and ensure r > g to avoid implausible valuations.
- Perform sensitivity analysis across g and r to show valuation range.