Reinvestment rate
DCFThe share of after tax operating profit a company puts back into the business to fund growth.
The reinvestment rate is net capital expenditure plus the increase in working capital, divided by NOPAT. It measures how much of what the business earns has to go straight back in rather than being available to investors.
It is one half of the growth identity: growth equals reinvestment rate multiplied by return on invested capital. A company reinvesting nothing cannot grow in real terms, however good its market.
In a terminal year it is the consistency check that catches inflated valuations. Whatever growth you have assumed implies a reinvestment rate given the ROIC, and the terminal cash flow must be struck after that reinvestment.
It also explains why two businesses with identical growth can be worth very different amounts. The one achieving that growth with less reinvestment converts more of its profit into cash available to investors, and is worth more for exactly that reason.
Worked example
A business earning 12% ROIC that reinvests 25% of NOPAT grows at 3.0%.
Raise assumed growth to 4% and the required reinvestment rises to 33% of NOPAT, so terminal free cash flow must fall accordingly.
Assuming the higher growth while leaving cash flow unchanged is the most common way a DCF quietly creates value from nothing.