What does the perpetuity growth rate represent in financial modeling?

The perpetuity growth rate represents a long-term growth rate at which a company's cash flows are expected to grow indefinitely into the future. In financial modeling, particularly when calculating the terminal value using the Gordon growth model, the perpetuity growth rate is often derived from a stable growth assumption for cash flows, typically aligned with the economy's inflation rate or GDP growth.

When we refer to it as an average growth rate, it's important to note that this is the rate of growth that is expected to persist indefinitely rather than fluctuating significantly year-to-year. This makes it a central component in determining the value of a business in perpetuity, based on its ability to generate cash flows over an infinite horizon.

The other options suggest either a decrease in cash flows or a fluctuating growth rate, which are not characteristics of a perpetuity growth rate. The perpetuity growth rate assumes steady, continuous growth, making it an essential concept for financial analysts when estimating a company’s value in ongoing operations. Thus, the correct interpretation is that the perpetuity growth rate reflects a consistent and sustainable average growth rate at which cash flows are anticipated to grow.