Terminal Value Flashcards
How do you calculate the Terminal Value?
Can either apply an exit multiple to company’s year 5 EBITDA, EBIT or FCF - called Multiples Method
OR
Use GGM to estimate value based on company’s growth rate into perpetuity:
Terminal Value = Final Year Free Cash Flow * (1 + Growth Rate) / (Discount Rate – Growth Rate).
Why would you use the Gordon Growth Method rather than the Multiples Method to calculate the Terminal Value?
Almost always use Multiples Method to calculate TV in a DCF, easier to get appropriate data for exit multiples since they are based on comparable companies.
May use GGM if you have no good comparable companies or if you believe that multiples will change significantly in the industry several years down the road. GGM used for cyclical industries.
What’s an appropriate growth rate to use when calculating the Terminal Value
Normally use country’s long-term GDP growth rate, rate of inflation or something similarly conservative.
For companies in developed countries, long term growth rate over 5% would be quite aggressive as most developed economies are growing at less than 5% per year.
How do you select the appropriate exit multiple when calculating Terminal Value?
Normally look at public comps and pick the median of the set.
Always show a range of exit multiples and what the TV looks like over that range rather than one specific number
So if the median EBITDA multiple of the set were 8x, might show a range of values using multiples ranging from 6x to 10x.
Which method of calculating Terminal Value will produce a higher valuation?
Impossible ti say, depends on assumptions
Can you explain the Gordon Growth formula in more detail? I don’t need a full derivation, but what’s the intuition behind it?
How much would you pay now upfront for expected growth in the future all to end up summed.
What’s the flaw with basing the Terminal Multiple on what the Public Comps are trading at?
Median multiples may change greatly in the next 5-10 years, so they may no longer be accurate by the end of the period you’re looking at. That’s why we look at a wide range of multiples and run sensitivity analysis.
why isn’t the present value of the Terminal Value, by itself, just the company’s Enterprise Value? Don’t you get Enterprise Value if you apply a multiple to EBITDA?
You do get enterprise value, but only get the far in the future value, not projection period value.
How do you know if a DCF is too dependent on future assumptions?
Some claim that if 50+% of a company’s value comes from the PV of the TV, DCF is too dependent on future assumptions.
How can you check whether your assumptions for Terminal Value using the Multiples Method vs. the Gordon Growth Method make sense?
Most common is to calculate TV using 1 method, and then see what the implied long-term growth rate or implied multiple via the other method would be.
