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dcf exit multiple

A new company with rapidly growing cash flows in the initial 5-year forecast period likely won’t see their growth in FCF drop below 4% in the short-medium term and their cost of equity will likely shrink as the stock’s risk profile lowers. But this won’t be captured under the Perpetuity Method as well as it can be captured by the Exit Multiple Method. The exit multiple method calculates the terminal value by using a multiple at the end of the projection period. Typically, you use the NTM or LTM EBITDA multiple, but you could also use a revenue multiple. The one constraint is that if you’re performing a DCF analysis on the enterprise value of a company, the multiple should be an enterprise value multiple (so not P/E).

What is an Exit Multiple?

The terminal multiple method inherently assumes that the business will be valued at the end of the projection period, based on public markets valuations. The terminal value is typically calculated by applying an appropriate multiple (EV/EBITDA, EV/EBIT, etc.) to the relevant statistic projected for the last projected year. Similarly, using an exit multiple of 25 implies that the perpetual growth rate is 1% at the same required rate of return. We can relationally dcf exit multiple analyze whether these assumptions are too high or too low if we understand how exit multiples and discount rates are interlinked. In financial modeling and analysis, this figure encompasses the value of all future cash flows beyond the forecasted period and is based on a specific growth rate or a specific multiple. The exit multiple model for calculating terminal value of a company’s cash flows estimates cash flows by using a multiple of earnings.

  • An appropriate range of multiples can be generated by looking at recent comparable acquisitions in the public market.
  • Investment bankers are not in the business of creating projections, and the client should have a stronger basis to project their own performance.
  • Once we discount each FCF and sum up the values, we get $127mm as the PV of the stage 1 FCFs – and this amount remains constant under either approach.
  • Practitioners like to compare investments in relation to similar investments, so they prefer to use the exit multiple method.
  • Today, we are going to take an in-depth look into two approaches that help simplify this process for investors.
  • The value of the business is obtained by multiplying financial metrics such as EBITDA or EBIT by a factor obtained from comparable companies that were recently acquired.

The investor will need to pick a financial metric that is usually a positive number for this industry’s incumbents (e.g., Revenue, EBITDA, etc.). For example, early-stage tech companies are often not very profitable, so the only financial metric practitioners have available to value them is their Revenue. We calculated the PV of projected cash flows in the Projected Cash Flows section of the template. Now we need to calculate the terminal value and then the PV of the terminal value.

Can You Have A Negative Terminal Value?

Another con of this method is that it’s difficult to use this method for a company with limited comparable companies. For example, there are companies that operate as monopolies or duopolies, or other companies operate in industries where the limited comps available aren’t a great fit with that company for valuation purposes. This method of computing Terminal Value is much simpler from an algebraic perspective. The logic used here is to determine how much the company could sell itself for at the end of the initial forecast period, and this value is equivalent to the pre-discounted terminal value. If we use a growth rate for the stock that’s above the country’s GDP growth, that means we are effectively saying that one day this stock will become more valuable than the country itself.

dcf exit multiple

The simplest and most common way to determine an exit multiple is to look at the market multiples of comparable companies or transactions. This approach assumes that the company you are valuing will be sold or traded at a similar multiple to its peers in the same industry, size, growth, and profitability. To use market comparables, you need to identify a relevant set of companies or transactions, collect their financial data, and calculate their multiples. Then, you can apply the average or median multiple to your company’s projected financial metric in the terminal year. When estimating a company’s cash flows in the future, analysts use financial models such as the discounted cash flow (DCF) method combined with certain assumptions to arrive at the value of the business. The DCF method assumes that the asset value equals the future cash flows generated by that asset.