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CS Professional · Corporate Restructuring, Valuation and Insolvency · Valuation of Business and Assets for Corporate Restructuring

A valuer values Vikram Chemicals Ltd by DCF. The terminal value forms 85% of the enterprise value, and the valuer is considering raising the perpetual growth rate from 4% to 6% with WACC at 11%. Which statement is correct?

Terminal value rises sharply. A higher growth rate narrows the gap between WACC and growth, from 7% to 5%, and also increases next year's cash flow. Since terminal value is 85% of enterprise value, the whole valuation becomes highly sensitive to this assumption.

  1. ATerminal value falls because a higher growth rate increases the denominator
  2. BThe change has little effect since terminal value is discounted heavily
  3. CTerminal value rises sharply, so the valuation becomes highly sensitive to the growth assumptionCorrect
  4. DOnly the explicit period cash flows change, not terminal value

Explanation

In the Gordon model TV = FCF x (1+g)/(WACC - g). The spread falls from 7% to 5%, and the numerator also rises, so TV increases by about 51%. With TV at 85% of value, the result is very sensitive to g, which is why sensitivity analysis is needed.

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