What is a key consideration when selecting the terminal growth rate using the Gordon Growth Method?

What is a key consideration when selecting the terminal growth rate using the Gordon Growth Method?

• A. It should exceed the company's projected growth rate
• B. It must be lower than the country's long-term GDP
• C. It should align with industry average growth rates
• D. It must equal the inflation rate

Answer: (B)

When selecting the terminal growth rate using the Gordon Growth Method, a fundamental consideration is that it must be lower than the country's long-term GDP growth rate. This is important because the terminal growth rate reflects the expected growth of free cash flows into perpetuity, and it should not exceed the economy's overall growth rate. If the terminal growth rate were to exceed the long-term GDP growth, it could lead to unrealistic assumptions about the company's ability to sustain such growth, ultimately resulting in an inflated valuation. Thus, maintaining a terminal growth rate that is sustainable and realistic, and below the long-term GDP growth rate, helps ensure that the valuation reflects achievable economic conditions while appropriately accounting for the company's position within its market and the economy at large.

When selecting the terminal growth rate using the Gordon Growth Method, a fundamental consideration is that it must be lower than the country's long-term GDP growth rate. This is important because the terminal growth rate reflects the expected growth of free cash flows into perpetuity, and it should not exceed the economy's overall growth rate. If the terminal growth rate were to exceed the long-term GDP growth, it could lead to unrealistic assumptions about the company's ability to sustain such growth, ultimately resulting in an inflated valuation. Thus, maintaining a terminal growth rate that is sustainable and realistic, and below the long-term GDP growth rate, helps ensure that the valuation reflects achievable economic conditions while appropriately accounting for the company's position within its market and the economy at large.