Free cash flows present value calculation : 3-period model

Free cash flows present value calculation : 3-period model

Around the formula...

Over three periods lasting n₁ years, n₂ years, and up to infinity (for example : years 0 to 5, years 6 to 10, years 11 to infinity...), cash flow rises by g₁ for n₁-1 years, then by g₂ for n₂ years and then by g₃ to infinity. Present value is then equal to:

This formula is useful when the growth rate is very high at the beginning of the period of projection, i.e. higher than the discounting rate, and then gradually declines.

Practically :

The first period growth and length will depend on the company's "visibility", i.e. the period of time over which is it reasonable to establish projections,

During the last period, free cash flows growth rate is similar to the one of the company's market or the economy as a whole or less,

The second period making the transition between both periods...