1. Calculating Terminal Value
So we've covered the two ways of calculating terminal value in a DCF,
the first one using a perpetual growth rate, and the second using an
EBITDA multiple or a terminal multiple. So we've given you enough information
here. What I'd like for you to do is to calculate the terminal value
using the perpetual growth rate as well as calculating the terminal value
using an EBITDA multiple. We've already practiced this in our exercise,
so let's apply it in our model, so give it a shot.
We'll come back and we'll walk through it together.
Okay. Now let's walk through this together. So we have five years of
unlevered free cash flows, but we need to take the last year,
in this case, 2027, and we're going to grow it
at one plus our terminal growth rate. Again, in our model,
we assume 2% discussed earlier that a terminal or perpetual growth rate
should be based on long term nominal GDP
of a mature market economy. Again, it's usually between 2% to 4%.
So now we have a hypothetical 2028 cash flow, okay? I'm calling it hypothetical
'cause our model doesn't go to 2028. But
you can think of that number, 10,977 as a 2028 number,
but let's apply the perpetuity calculation to get the terminal value.
So we divide that cash flow by WACC minus our
perpetual growth rate, and we have a terminal value of 118.
It's actually millions of dollars. Okay. Now let's go down and calculate
the terminal value using the EBITDA multiple. So we need to pull in
our 2027 EBITDA. So we can either pull it
from our unlevered free cash flow or we can pull it from the
schedule above. You can even pull it from the income statement if we
wanted to. We'll take our EBITDA and we'll multiply it by a 7.2
times terminal multiple, and we get 158 and a half million dollars.
Now again, just as a reminder, the terminal multiple method assumes the
shareholders of the target company sell their shares at the end of the
year. Again, this is not a problem if we are using end of
period discounting. We're not a discounting yet, but we will very shortly.
So it's not a problem if we use into period discounting,
but if we use, say, mid period or the middle of the year
discounting, then there's a mismatch in timing because again,
the assumption is the terminal value, the terminal multiple approach is
at the end of the year. Now it's not that big of a
deal because of what we're going to do is we're actually just going
to average the two terminal values together, so we'll reference the terminal
value using the perpetual growth rate, we'll reference the
terminal value using our terminal multiple, and we'll just average those
together. We'll select those and on average, you see it's about 138 and
a half million dollar, okay? Now you may or may not see this
averaging in practice. A lot of firms will average
terminal values, others are steadfast against it. In this case, we're just
going to go ahead and average the two.
2. Let's practice!