Lesson Outline:

How Do You Pick the Terminal Multiple in a DCF?

Idea: For the Terminal Value, you need to estimate the company's value in the "far future" period what
are all those cash flows worth if you go past Year 5 here, or if you go past Year 10 in a 10-year model?
Two methods: the Multiples Method, where you assign an EBITDA multiple to the final year EBITDA,
assume the company gets sold, and value it like that; or the Gordon Growth or Perpetual Growth or LongTerm Growth Method, where you assume it operates
indefinitely.
Need to make sure both methods make sense by themselves, and that the implied multiple and the
implied growth rate from both methods seem reasonable.
The Multiples Method Selecting a Multiple
You might START by getting the median EBITDA multiple or range of multiples from the set of public
comps, and then applying them to this companys appropriate figure in the final projection year BUT
You generally want to assume a discount over historical multiples, and even over forward multiples. Why?
1. Multiples generally decline over time as companies get bigger and growth slows down, so investors
won't pay as much.
2. The "Terminal Multiple" must imply a reasonable Terminal Growth Rate if you get something like a
10% FCF growth rate implied by your Multiple, you should be VERY suspicious - no company has ever
grown at that rate for decades!
(Of course, this also depends on the discount rate - with a higher discount rate, higher growth might be
justified.)
3. You also care more about the RANGE of Terminal Values and implied Enterprise Values from a RANGE
of reasonable multiples (ex: 25th to 75th percentile of comps, modestly discounted).
How do you get the implied Terminal Growth Rate from a Terminal Multiple?
Implied Terminal Growth Rate = (Terminal Value * Discount Rate Final Year FCF) / (Final Year FCF
+ Terminal Value)
Derivation: Please see the PowerPoint slides or PDF at the top. You start out with the familiar Terminal
Value formula, Final Year FCF * (1 + Growth Rate) / (Discount Rate Growth Rate), and then use algebra
to get the Growth Rate on one side of the equation.
You have to go through a few steps to do this, but its fairly simple algebra.
How do you decide if this is an appropriate implied Growth Rate?
It should ideally be LESS than the GDP growth rate of the country this company is in, which means a very

low percentage in most developed countries (e.g., less than 3% in the US) because all companies slow
down to the rate of growth of the overall economy, or less, in the long-term.
You could also look at the expected long-term FCF growth rates of comparables, or the growth rates
implied by their multiples. Some people also use other macroeconomic indicators like the inflation rate as
a guideline.
Conclusions From This Analysis:
The baseline multiple of 5.9x we used isn't "wrong" necessarily, but we should probably project further
into the future and create a 10-year DCF because the NPV of the Terminal Value comprises over 70% of
the total implied value right now it should ideally be ~50% or less.
We should also probably pick narrower ranges for these tables 4.5x to 8.5x is too wide a range and may
not even be meaningful.
And the company was almost certainly overvalued at the time we did this analysis, since nearly all the
values were below the current share price of $17.87.
We only get values above $17.87 if the assumptions are *very* optimistic, indicating that the company is
overvalued or that our assumptions such as the discount rate are incorrect.