Another important concept is that of the Terminal Value in cash flows. In most projects once you have modelled say 10 years, you want to stop. You don’t want to model forever. But in real life the project won’t just stop at that point.
You may be able to sell it in its entirety, or sell the assets or perhaps you have a cost you have to pay to close the project (think environmental costs on a mine).
How you come up with this terminal value depends on a lot of things.
Perhaps you use a rule of thumb ( e.g. these types of businesses sell for 3 x EBITDA) or you can use the Gordon Growth Model.
The important part for our purposes is how you discount it back into your NPV.
If you use the Gordon Growth Model method [ Price in 0= Div in 1 ÷ (WACC – growth rate ) ], you need to use the PREVIOUS periods discount factor, NOT the current one.
To follow along go to 17.13
As shown below, even though we are now in year 6 (cell J33) we use the same discount factor (J40) as used in year 5 (I40). This is then added to the discounted cash flows.