What is the purpose of the Gordon Growth method?

What is the purpose of the Gordon Growth method?

• A. To adjust cash flows for taxes
• B. To estimate terminal value based on perpetual growth
• C. To compute initial FCF
• D. To determine levered beta

Answer: (B)

The Gordon Growth Model provides a simple way to convert a perpetually growing stream of cash flows into a single present value. It assumes the cash flow grows at a fixed rate forever, so the value of all futureCash flows beyond the explicit forecast period—the terminal value—can be calculated with the formula TV = CF1 / (r − g). This is exactly how terminal value is often estimated in a discounted cash flow, capturing the value of cash flows that continue indefinitely under steady growth. This approach is not about adjusting cash flows for taxes, nor about computing the initial forecasted free cash flow, nor about determining levered beta. Those are separate concepts; the Gordon Growth Model specifically targets terminal value under perpetual growth.

The Gordon Growth Model provides a simple way to convert a perpetually growing stream of cash flows into a single present value. It assumes the cash flow grows at a fixed rate forever, so the value of all futureCash flows beyond the explicit forecast period—the terminal value—can be calculated with the formula TV = CF1 / (r − g). This is exactly how terminal value is often estimated in a discounted cash flow, capturing the value of cash flows that continue indefinitely under steady growth.

This approach is not about adjusting cash flows for taxes, nor about computing the initial forecasted free cash flow, nor about determining levered beta. Those are separate concepts; the Gordon Growth Model specifically targets terminal value under perpetual growth.