What does the perpetual growth method calculate?

The perpetual growth method is primarily used to calculate the terminal value of a company at the end of a forecast period by assuming that free cash flows will continue to grow at a constant rate indefinitely. This technique is essential in financial modeling because it allows analysts to estimate the value of a business well beyond the explicit forecast period.

In applying the perpetual growth model, financial analysts typically take the last projected cash flow and multiply it by a growth factor that reflects the expected long-term growth rate. This method assumes that once the initial forecast period is over, the company will continue to generate cash flows that grow at a stable rate forever, thus providing a way to capture the ongoing value of the company.

Other options refer to different aspects of financial valuation or analysis but do not encompass the specific function of the perpetual growth method. For instance, the value during the forecast period refers to cash flows that are projected under specific assumptions rather than an indefinite growth model, while overall profitability deals with net income rather than cash flow continuity. Total cash flow generated in a single year looks at a snapshot rather than the sustained value realized over time.