Terminal Growth Rate
Definition - What does Terminal Growth Rate mean?
Terminal growth rate is an estimate of a company’s growth in expected future cash flows beyond a projection period. It is used in calculating the terminal value of a company as follows:
Terminal Value = (FCF X [1 + g]) / (WACC - g)
FCF (free cash flow) = Forecasted cash flow of a company
g = Expected terminal growth rate of the company (measured as a percentage)
WACC = Weighted average cost of capital
Divestopedia explains Terminal Growth Rate
The terminal growth rate represents an assumption that the company will continue to grow (or decline) at a steady, constant rate into perpetuity.
It is expected that the growth rate should yield a constant result. Otherwise, multiple stage terminal value must be calculated at points when the terminal growth rate is expected to change. If the growth rate, however, turns out to be negative (or declining), then it is assumed that the company will fail and eventually dissolve in the future.
Typically, perpetuity growth rates range between the historical inflation rate of 2 - 3% and the historical GDP growth rate of 4 - 5%. If the perpetuity growth rate exceeds 5%, it is basically assumed that the company's expected growth will outpace the economy's growth forever.
There is a significant amount of judgement in the estimation of the terminal growth rate and determining when the company achieves steady-state.