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

Question

Quizplus · Accepted Answer

The cap rate is measured as the equity discount rate minus the perpetuity growth rate. This is because the terminal value calculation aims to estimate the value of all future cash flows beyond a certain point, taking into account the expected growth of these cash flows over time. Subtracting the perpetuity growth rate from the equity discount rate adjusts for the fact that the cash flows are expected to grow at a certain rate indefinitely.

When Estimating the Terminal Value of a Venture Using an Equity