Simple Errors or Myths in Dealing with Perpetuities

Abstract

Terminal value is critical for valuation purposes because very often it is a large part of what constitutes the value of a firm. In this short note I answer and clarify some typical questions and myths related to the calculation of terminal value. They are related to the use of non growing perpetuities, inflation and real growth; the use of Net Operating Profits Less Adjusted Taxes, NOPLAT as a proxy to the Free Cash Flow in perpetuity; the use of the typical textbook formula for estimating terminal value; and the treatment of working capital in perpetuities.

Keywords: Terminal value, continuing value, perpetuities, firm value, equity value, cost of capital in perpetuity

JEL Classification: D61, G31, H43