Capitalization 2.0 – Terminal Value Under Changing Capital Structure

20 Pages Posted: 28 Jan 2020

Date Written: January 2, 2020


Terminal Value (aka Horizon Value) is the value of a firm when the firm is expected to grow at a constant rate forever. The method to calculate value a constant-growth firm is sometimes called Capitalization. Currently, and for decades, the primary method, if not the only method, to calculate Terminal Value is a formula commonly known as the Gordon Growth Model (GGM). In addition to the constant growth assumption, Gordon Growth Model assumes “constant capital structure” which results into “Constant WACC” (Weighted Average Cost of Capital) as a discount rate. This paper will show following: 1) The “constant WACC” assumption of the Gordon Growth Model implies that the capital markets will accept “Dividend First” financing terms. However, the capital markets function with “Debt First” financing terms. When a firm operates with “Debt First” financing terms, but the value is based on “Dividend First” financing terms, the equity IRR is less than expected. This means GGM overvalues a firm. And, such over valuation is material, 10 to 50% and sometimes even more. 2) Introduce Advance Growth Model (AGM) to value a constant-growth firm assuming capital markets acceptable “Debt First” financing terms. AGM formula is a generalized formula for Terminal Value; AGM value is equal to GGM value if GGM assumptions are plugged into the AGM formula.

GGM formula is very elegant; AGM formula is very complex even though it has only 3 more input variables. A free spreadsheet with GGM and AGM formulas is available in the main article.

Keywords: Valuation, Terminal Value, DCF, WACC, Discounted Cash Flow, Gordon Growth Model, Dividend Distribution Model

JEL Classification: G32

Suggested Citation

Adhikari, Mike, Capitalization 2.0 – Terminal Value Under Changing Capital Structure (January 2, 2020). Available at SSRN: or

Mike Adhikari (Contact Author)

Business ValueXpress ( email )

175 Olde Half Day Rd., #130
Lincolnshire, IL 60069
United States
847-4381657 (Phone)


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