Gordon Growth Model: terminal value as a constant-growth perpetuity
The Gordon Growth Model values terminal cash flows as a perpetuity growing at a constant rate g, discounted at WACC. It is the default terminal-value method in academic finance and the most-taught formula in CFA, MBA, and analyst training.
Where the formula comes from
Gordon Growth is a specific application of the constant-growth perpetuity, which itself derives from the standard discount-factor sum.
Start with the present value of an infinite stream of cash flows growing at constant rate g, discounted at rate r:
This is a geometric series with first term CF1 / (1+r) and common ratio (1+g) / (1+r). For the series to converge we need r > g. The closed-form sum is:
Apply this to terminal value at the end of a forecast horizon n. The terminal cash flow CF1 is the first post-forecast year, which equals FCFn * (1 + g). The discount rate r is WACC. Substituting:
That is the Gordon Growth Model for terminal value. The critical assumption is that the cash flow grows at a constant rate g forever. The critical constraint is g < WACC.
Terminal value as a function of g and WACC
Illustrative table for terminal-year FCF of $100M. Values are TV in millions. The sensitivity is acute as g approaches WACC.
| WACC \ g | 0.0% | 1.0% | 2.0% | 2.5% | 3.0% | 4.0% |
|---|---|---|---|---|---|---|
| 7% | $1,429 | $1,684 | $2,057 | $2,289 | $2,575 | $3,467 |
| 8% | $1,250 | $1,444 | $1,717 | $1,879 | $2,073 | $2,600 |
| 9% | $1,111 | $1,264 | $1,469 | $1,586 | $1,722 | $2,080 |
| 10% | $1,000 | $1,124 | $1,287 | $1,378 | $1,481 | $1,733 |
| 11% | $909 | $1,011 | $1,144 | $1,217 | $1,297 | $1,486 |
| 12% | $833 | $919 | $1,031 | $1,090 | $1,153 | $1,300 |
Read horizontally: at WACC of 8%, moving g from 2.0% to 3.0% raises TV by 21%. Moving g from 3.0% to 4.0% raises TV by 25%. Small changes in g, large changes in TV.
Three conditions that invalidate Gordon Growth
The closed-form sum requires r > g for the geometric series to converge. With g equal to or greater than WACC the formula diverges to infinity. The calculator returns 'Diverges' in this case.
Gordon Growth assumes a single perpetuity growth rate forever. If the business is still scaling, deleveraging, or transitioning margins, the steady-state assumption is violated. Use a two-stage model.
Growth at g requires reinvestment of g / ROIC of operating cash flow. If your perpetuity growth rate implies reinvestment that exceeds the FCF you are discounting, you have double-counted growth. The key-value driver formula in Koller addresses this explicitly.
Try the Gordon Growth side of the calculator
The live calculator computes Gordon Growth and Exit Multiple terminal values side-by-side, with a cross-check showing divergence between the two methods.
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