Gordon Bike Company\'s Terminal Value using a trailing PE multiple is equal to w

Question

Gordon Bike Company's Terminal Value using a trailing PE multiple is equal to which of the following?

A) Multiply the PE multiple by the nominal net income for the last year of the forecast period (year x).

B) Multiply the PE multiple by the nominal free cash flow for the year after the end of the forecast period (year x+1).

C) Multiply the PE multiple by the nominal free cash flow for the last year of the forecast period (year x).

D) Multiply the PE multiple by the nominal net income for the year after the end of the forecast period (year x+1).

Explanation / Answer

C) Multiply the PE multiple by the nominal free cash flow for the last year of the forecast period (year x).

reason:

If it is assumed that the free cash flow in the final year of the forecast horizon
grows at the perpetual growth rate, then the growing perpetuity formula can be rewritten as follows:
Perpetual Growth Rate =(TV * r) - FCF/(TV +FCF)
TV = terminal value.
r = discount rate in perpetuity (i.e., WACC).
FCF = free cash flow in the final year of the projection period.

The formula for a growing perpetuity(1) is:
Terminal Value =X/(r-g)
X = free cash flow in the first period of the perpetual stream.
r = discount rate in perpetuity (i.e., WACC).
g = perpetual growth rate.

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