After projecting FCF for the horizon, what is used to estimate cash flows beyond the projection period?

After projecting FCF for the horizon, what is used to estimate cash flows beyond the projection period?

• A. Terminal value
• B. Annuity method
• C. Inflation adjustment
• D. Perpetuity growth rate only

Answer: (A)

When you forecast Free Cash Flow over a finite horizon, you still need a way to capture all the cash flows that occur after that period. That future value is called the terminal value, and it represents the present value of all subsequent cash flows beyond the projection horizon. In practice, the terminal value is usually calculated with a perpetuity growth approach: take the next year's FCF and divide it by (WACC minus the long-term growth rate). This method combines the level of cash flow at the end of the projection with an assumption about steady growth forever, then discounts it back to today. Why this is the best choice here: it provides a single, lump-sum value that accounts for the continuing value of the business after the forecast period, rather than attempting to model an indefinite stream step by step. The other options don’t fit because an annuity method implies a fixed, finite stream; inflation adjustment only tweaks levels for price changes without estimating ongoing cash flows; and using only a perpetuity growth rate lacks the starting cash flow and discount rate needed to produce a concrete terminal value.

When you forecast Free Cash Flow over a finite horizon, you still need a way to capture all the cash flows that occur after that period. That future value is called the terminal value, and it represents the present value of all subsequent cash flows beyond the projection horizon.

In practice, the terminal value is usually calculated with a perpetuity growth approach: take the next year's FCF and divide it by (WACC minus the long-term growth rate). This method combines the level of cash flow at the end of the projection with an assumption about steady growth forever, then discounts it back to today.

Why this is the best choice here: it provides a single, lump-sum value that accounts for the continuing value of the business after the forecast period, rather than attempting to model an indefinite stream step by step. The other options don’t fit because an annuity method implies a fixed, finite stream; inflation adjustment only tweaks levels for price changes without estimating ongoing cash flows; and using only a perpetuity growth rate lacks the starting cash flow and discount rate needed to produce a concrete terminal value.