8/19/2019 How to Pick the Terminal Multiple to Calculate Terminal Value in a DCF

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Lesson Outline:

How Do You Pick the Terminal Multiple in a DCF?

Idea: For the Terminal alue! "ou need to estimate the compan"#s $alue in the %&ar &uture% period' whatare all those cash &lows worth i& "ou (o past Year ) here! or i& "ou (o past Year *+ in a *+,"ear model?

Two methods: the Multiples Method! where "ou assi(n an -.ITD/ multiple to the &inal "ear -.ITD/!assume the compan" (ets sold! and $alue it like that0 or the 1ordon 1rowth or Perpetual 1rowth or Lon(,Term 1rowth Method! where "ou assume it operatesinde&initel"2

3eed to make sure 4oth methods make sense 4" themsel$es! and that the implied multiple and theimplied (rowth rate &rom 4oth methods seem reasona4le2

The Multiples Method 5 6electin( a Multiple

You mi(ht 6T/7T 4" (ettin( the median -.ITD/ multiple or ran(e o& multiples &rom the set o& pu4liccomps! and then appl"in( them to this compan"8s appropriate &i(ure in the &inal pro9ection "ear' . T'

You (enerall" want to assume a discount o$er historical multiples! and e$en o$er &orward multiples2 ;h"?

*2 Multiples (enerall" decline o$er time as companies (et 4i((er and (rowth slows down! so in$estorswon#t pa" as much2

O& course! this also depends on the discount rate , with a hi(her discount rate! hi(her (rowth mi(ht 4e 9usti&ied2@

A2 You also care more a4out the 7/31- o& Terminal alues and implied -nterprise alues &rom a 7/31-o& reasona4le multiples eB:

8/19/2019 How to Pick the Terminal Multiple to Calculate Terminal Value in a DCF

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low percenta(e in most de$eloped countries e2(2! less than A= in the 6@ 4ecause all companies slowdown to the rate o& (rowth o& the o$erall econom"! or less! in the lon(,term2

You could also look at the eBpected lon(,term FCF (rowth rates o& compara4les! or the (rowth ratesimplied 4" their multiples2 6ome people also use other macroeconomic indicators like the in&lation rate asa (uideline2

Conclusions From This /nal"sis:

The 4aseline multiple o& )2JB we used isn#t %wron(% necessaril"! 4ut we should pro4a4l" pro9ect &urtherinto the &uture and create a *+,"ear DCF 4ecause the 3P o& the Terminal alue comprises o$er += o&the total implied $alue ri(ht now 5 it should ideall" 4e K)+= or less2

;e should also pro4a4l" pick narrower ran(es &or these ta4les 5 2)B to 2)B is too wide a ran(e and ma"not e$en 4e meanin(&ul2

/nd' the compan" was almost certainl" o$er$alued at the time we did this anal"sis! since nearl" all the

$alues were 4elow the current share price o& N* 2 2

;e onl" (et $alues a4o$e N* 2 i& the assumptions are $er" optimistic! indicatin( that the compan" iso$er$alued or that our assumptions such as the discount rate are incorrect2