Because the free cash flow to firm is the after tax cash available for use after paying out all expenses nessecary to keep the business running. So we also subtract from the NOPAT the percentage required to do so. You should also add back depreciation, since it is a non-cash expense included in the calculation of NOPAT.
This gives you FCF = NOPAT * (1-ReInv), with (1-ReInv) being another term for retention rate. which is similar to the retention rate on dividend payout ratios.
Terminal, or continuing value is a function of a perpetutiy assumption. So you multiply this year’s cash flow by the sustainable rate of growth (giving you CF for t=1 in the numerator) and dividing that by the required rate of return minus the sustainable growth rate.
In this instance, you could achieve the same results using the retention rate instead. I’ll show you why.
FCF = NOPAT - Net Investment
ReInv rate (%) = Net Investment / NOPAT
Therefore FCF = NOPAT * (1-ReInv) (1)
Similary, growth of cash (g) = RONIC * ReInv (2)
This means that a company grows it’s FCF by the proportion of reinvested cash on it’s return on newly invested capital. So if I make 25% on every dollar I invest, and I put back 80% of what I earn to reinvest, then I am growing my company by 0.25c * 80% = 0.20c every year.
ReInv can also be equal to ReInv = g / RONIC (3) based on the above.
Therefore from (1) and (3), FCF = NOPAT ( 1 - g / RONIC)
Now that we established that perpetuity = FCF at t1 / WACC - g, we can rebuild the perpetuity formula to include NOPAT instead as the value driver.
Which gives us V = NOPAT (1 - g / RONIC) divided by WACC - g
In other words, he has substituted the plain perpeturity forumla using only g as the value driver with another important value driver. Since growing faster than you earn a return will give you a lower continuing value, something you can’t derive from g alone, in addition to making an assumption of future returns on invested capital for the explicit period of the forecast, which is generally lower than earlier years, and in many cases, equal to WACC.
The book on Valuation by Koller, Damodaran’s Investment Valuation, Rosenbaum’s Investment Banking should be all good. I’d also recommend the Investment Checklist as the best book on performing proper research on companies to invest in,