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Risk Latte - Valuation of Perpetual Cash flows

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Valuation of Perpetual Cash flows
Team Latte
Apr 29, 2007

This is in continuation of the previous article on valuation of a company using perpetual cash flows. The logic and rationale presented here is from the excellent explanation in Brealey and Myers (2005).

Let's look at a stream of cash flows which goes on into perpetuity when the discount rate or the yield is :

...........(1)

Now define and . With these definitions in place the above equation (1) becomes:

.....................(2)

Now multiply both sides by to give the following equation:

.....................(3)

Subtracting equation (3) from (2) gives:

The above equation reduces to:

.....................................................................(4)

This is the valuation formula for a cash flow which goes on to perpetuity.

 

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