When estimating the terminal value of a venture using an equity valuation method, a perpetuity growth equation is often applied that uses the capitalization rate for discounting purposes. This "cap" rate is measured as the:
A) equity discount rate minus the perpetuity growth rate
B) equity discount rate plus the perpetuity growth rate
C) risk-free rate plus the perpetuity growth rate
D) risk-free rate minus the perpetuity growth rate

Question

Quizplus · Accepted Answer

The capitalization rate in the perpetuity growth model is calculated as the equity discount rate minus the perpetuity growth rate. This reflects the expected return on equity adjusted for the growth rate of the cash flows.

When Estimating the Terminal Value of a Venture Using an Equity