Module II· DCF — Mechanics & FCFIntermediate
Question
What does 'normalized FCF in the terminal year' mean and why is it critical?
Answer
Mechanics
In the terminal year the FCF must be sustainably repeatable — otherwise it destroys the terminal value. Normalization points:
- D&A ≈ capex (no more growth capex).
- ΔNWC = NWC × g (only inflation/growth needs).
- Margins at a sustainable level (no one-off effects, no cyclical peak).
- Taxes at the long-run tax rate (no more NOL benefit).
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Consequence
Terminal-year FCF is often lower than Year 5 FCF, because capex is normalized upward. A classic mistake: plugging Year 5 FCF directly into Gordon — overvalued, because Year 5 is often still in the growth phase with low maintenance capex.