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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