Case 016ValuationWarm up
A logistics company will generate Rs 50 crore of free cash flow next year, growing 15% a year to year 5 and 5% after. What is it worth, and how much comes from the terminal value?
1The situation
Rathchakra Logistics will generate free cash flow to the firm of Rs 50 crore next year. Cash flow grows 15% a year in years 2 to 5, then 5% a year for ever. Its WACC is 12%. Cash flows arrive at the end of each year.
2Your task
Work out enterprise value with a five-year DCF and a growing perpetuity, and say what share of the value sits in the terminal value.
Quick check
Roughly what share of Rathchakra's value comes from the terminal value?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
Enterprise value is about Rs 980 crore, and about 76% of it comes from the terminal value. The five explicit years, Rs 50 crore growing to Rs 87.5 crore, are worth Rs 235 crore today. The terminal value at year 5 is Rs 1,312 crore, worth Rs 744 crore today. That is normal for a growing business, and it is why the terminal assumptions deserve the most scrutiny.
Step 1What are the pieces of a simple DCF?
A DCF says a business is worth the cash it will produce, each rupee scaled down for how long you wait. For a business that grows fast and then settles, that is a handful of explicit years plus one terminal valueThe value at the end of the forecast of all cash flows after it, usually a growing perpetuity: next year cash flow divided by the discount rate less the growth rate. that stands for everything after. A landlord valuing a flat does the same thing in his head: the next few years of rent he can see, then a rough figure for what the flat is worth after that.
Step 2What are the five explicit years worth?
Grow Rs 50 crore at 15%: Rs 50.0, 57.5, 66.1, 76.0 and 87.5 crore. Discount each at 12% for the years you wait: year 1 is divided by 1.12, year 5 by 1.12 to the fifth, 1.762. The values today are almost flat, Rs 44.6 crore to Rs 49.6 crore, because 15% growth barely outruns 12% discounting, and together they come to Rs 235.5 crore.
| Year | Free cash flow | Discount factor at 12% | Value today |
|---|---|---|---|
| 1 | 50.0 | 0.8929 | 44.6 |
| 2 | 57.5 | 0.7972 | 45.8 |
| 3 | 66.1 | 0.7118 | 47.1 |
| 4 | 76.0 | 0.6355 | 48.3 |
| 5 | 87.5 | 0.5674 | 49.6 |
| Explicit years | 235.5 | ||
| Terminal value at year 5 | 1,311.8 | 0.5674 | 744.3 |
| Enterprise value | 979.8 |
Step 3How is the terminal value built, and why is it so large?
| FCF_5 | year 5 free cash flow |
| g | growth for ever after year 5, 5% |
| r | WACC, 12% |
The perpetuity divides by the gap between discount rate and growth, 7%, which is the same as multiplying by about 14. A business that grows for ever earns most of its value after any forecast window, so a 76% terminal share is a property of the arithmetic, not a sign of error. The sign of error is a terminal value whose inputs nobody tested.
Step 4What would you test first?
Terminal growth and the discount rate, because they act through that 7% gap. At 4% terminal growth enterprise value falls to about Rs 881 crore; at 6% it rises to about Rs 1,112 crore, a swing of about 24% from two points of growth. Also check the step from 15% to 5%: a real business slows gradually, so a fade over years 6 to 10 is more honest than a cliff. And keep terminal growth at or below long-run nominal growth of the economy, since no business outgrows its economy for ever.
Where candidates lose it
The common slip is discounting the terminal value by six years because it starts with year 6 cash flow. The formula already values it at the end of year 5, so divide by 1.12 to the fifth; using six years gives Rs 900 crore and understates value.
The second is using year 5 cash flow in the numerator without growing it by 5%, which also understates the terminal value.
What the interviewer asks next
- What exit EV to EBITDA multiple would you need to cross-check this terminal value?
- How would a mid-year convention change the answer?
- Growth fades from 15% to 5% over years 6 to 10 instead. Higher or lower value, and why?
Asked at HPS Investment Partners, Asset Management, New York, 2025 (Wall Street Oasis): Then got sent the case study, very simple DCF for a fake business.
Company names and figures are illustrative.