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Chapter 13

2.4 Forecasting growth in FCF

The method above has identified a figure for the FCF based on the current financial
statements. In order to value the business, the future FCF needs to be forecast and
then discounted.

To forecast the likely growth rate for the FCF, the following methods
can be used:

 Historical estimates. For example, if the business has achieved
growth of 5% per annum each year for the last five years, 5% may
be a sensible growth rate to apply to future FCF.

 Analyst forecasts. Particularly for listed companies, market
analysts regularly produce forecasts of growth. These independent
estimates could be a useful indicator of the likely future growth
rate.

 Fundamental analysis, using Gordon's growth approximation, g =
b × r e, where r e is the return on equity (cost of equity) and b is the
earnings retention rate.

 Alternatively, in an exam question, you may simply be told which
growth rate to apply.

Illustrations and further practice

Now try TYU 1 in Chapter 13

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