facebookCan terminal value be negative in a DCF model? - Seedly

Anonymous

04 Dec 2019

βˆ™

General Investing

Can terminal value be negative in a DCF model?

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Isaac Chan

04 Dec 2019

Business at NUS

Yes it can be negative!

This might theoretically be possible if you use the perpetuity growth method to calculate terminal value. If you refer to the formula, this is derived when the free cashflow growth rates exceed the cost of capital.

However this does not make sense for 2 reasons.

  1. If your FCF is growing faster than the cost of capital, it would mean that investors would flock in and to pump in their capital into the business since their return on their capital would be higher than their cost (if you maintain that WACC doesn't change).
  2. The higher a company's perpetuity growth rate, the more value the company has. But when growth rates exceeds WACC, value seems to be eroded rather than destroyed for the company, since your terminal value is now negative. This therefore does not make much sense.

Moreover, if growth rate equals to WACC, the denominator would be 0, which suggests that the value of the company is infinite. Again, this is illogical.

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