Breaking Into Wall Street 400 Practice Test

The concept being tested is the Gordon Growth Model for a terminal value in a growing perpetuity. In this model, the value of all future cash flows beyond the terminal year is equal to the next year’s cash flow divided by the discount rate minus the growth rate: TV = CF1 / (r - g). If you start from the current year free cash flow (FCF), you must grow it to next year’s level: CF1 = FCF × (1 + g). Substituting gives TV = FCF × (1 + g) / (r - g). That is why the correct form uses FCF times (1 + g) in the numerator and the difference (r - g) in the denominator. The other forms aren’t correct here: using FCF without growing it assumes the cash flow is already next year’s, which isn’t indicated; using r + g in the denominator is incorrect for this model, and using (1 - g) in the numerator implies a shrinking perpetuity, which isn’t the standard Gordon Growth setup.