1. Terminal Value Walkthrough
So we've calculated the unlevered free cash flows in our main model,
but we want to practice calculating terminal value in this exercises file
as there's a lot of confusion regarding terminal value.
So we have a simple example, and we're going to calculate the terminal
value using the perpetual growth method, and another terminal value using
the terminal multiple method. Both are widely used in practice.
So we'll start by using the perpetual growth method.
So we've already given you a series of cash flows, and the number
of years to discount. Let's go over and set up the terminal free
cash flow section over here. Again, the gray shading is just
an identifier for us to know what to work in. So with the
terminal value, regardless of whether you're using the perpetuity growth
method or the terminal multiple method, the timing is always the same as
the last year's timing in your discreet forecast stage,
we're gonna set that equal. And of course, you can see
right here, we have our discount rate and our perpetual growth rate,
you need those. So we'll take our year 5 cash flow,
and we're going to grow it at that perpetual growth rate
of 2% in this instance. Then in order to get the actual terminal
value, we take that cash flow divided by
our discount rate or WACC minus that perpetual growth rate.
And we arrive at 133,302. Now, real quick, this captures all of the
value after year 5, it is in fact a present value calculation to year
5, however, we still need to discount that
back to the present value, not to its year 5 value.
Okay, now let's calculate our total cash flows in this
terminal year, the cash flow is really just that terminal value we just
calculated, okay? And now we can present value each one of those cash
flows. So we'll just take our cash flow divided by one plus our
discount rate, make sure you anchor it with F4, and then we'll raise
it to the power of one, because this cash flow is going to
occur in one year. And now we can
take these and paste them forward. And again,
since the terminal year, we're discounting it for five years.
It's as if it occurred in this year,
mathematically it does. So again, that's the reason why we always want to
link... Our terminal timing is always the last
year or period in our discrete forecast stage.
Now that we have the present value of our cash flows,
we can simply sum those up and derive enterprise value.
Now let's move down and calculate the terminal value using a terminal EBITDA
multiple. So you can see we have our discount rate, it's the same
discount rate as above, but in this case,
we're assuming a seven times EBITDA multiple. Okay, so let's set up the
terminal value section. As always, again, the timing
always corresponds to the last period in your discrete stage,
okay? And then we have EBITDA. Now, when we use the EBITDA multiple
approach, we take the last year's EBITDA as our
number in order to determine terminal value under this methodology.
And the reason being is that we assume that at the end of
year 5, the company is going to be acquired for some multiple of
EBITDA. And so we use that year five EBITDA, the last 12 months
EBITDA in order to calculate our terminal value under this methodology.
So now we can take our EBITDA and we'll multiply it by our seven
times EBITDA multiple to get our terminal value. Again, note
there are no cash flows associated with this, because the cash flows are
already being accounted for in year 5, so we don't need to fill
out anything there. Now we can simply present value the cash flows just
like before, divided by one plus our discount rate.
Raise it to the years in which these cash flows will be received,
copy it forward, and then we can sum all of the present value
of all of those cash flows, and we have yet another enterprise value
in this case 105,764. Again, I know I'm repeating myself a little bit,
but regardless of whether you use the perpetuity growth method or the terminal
multiple method, you still need to use the last year's timing.
In other words, the terminal value calculation already discounts the terminal
value back to the last year in your explicit or discrete forecast period,
in this example, it's year five, so that's why we set these equal.
And another point on the terminal or exit multiple method,
this method assumes the business will be acquired
on the last day of the fiscal year.
So this isn't a problem if we use end of period discounting for
our cash flows, however, if we use mid period discounting for cash flows,
then we will have an inconsistency when using the terminal multiple approach,
again, which is assumed to be at year end.
2. Let's practice!