How to Choose and Justify Exit Multiples

Next, the Year 5 FCF of $36mm is going to be multiplied by the 2.5% growth rate to arrive at $37mm for the FCF value in the next year, which will then be inserted into the formula for the calculation. In theory, the exit multiple serves as a useful point of reference for the future valuation of the target company in its mature state. The long-term growth rate assumption should generally range between 2% to 4% to reflect a realistic, sustainable rate. The long-term growth rate should theoretically be the growth rate that the company can sustain into perpetuity. But eventually, simplified high-level assumptions become necessary to capture the lump sum value at the end of the forecast period. Since neither terminal value calculation is perfect, investors can benefit by doing a DCF analysis using both terminal value calculations and then using an average of the two values for a final estimate of NPV.

Be consistent with the multiples you’re showing – if you’re using a LTM multiple for the Exit Multiple Method, you should calculate the implied LTM multiple here. But per the discussion of mid-year discounting above, this unfairly penalizes the value of the company – assuming the company’s cash flows occur relatively evenly throughout the year. A growth rate of cash flows that are higher https://personal-accounting.org/main-types-of-income-statement/ than the GDP growth rate would indicate that the company would grow faster than the economy. This cannot happen without the company becoming larger than the economy itself. Academics like the perpetuity growth method better because it is theoretically sound and has a stronger economic rationale. As both methods are interlinked, one can be used to derive the value of the other.

Which Terminal Valuation Methodology is Better?

So, if only 5-10 years of FCF is forecasted in stage 1, how does an investor determine the value of FCF in the 11th year? Check Your MultipleSelecting an appropriate exit multiple range is key, and it helps to have knowledge of the industry. In my model I have come up with the EV based on discounted FCFs from 2015 to 2019.

• We can relationally analyze whether these assumptions are too high or too low if we understand how exit multiples and discount rates are interlinked.
• This means that an industry multiple is applied rather than applying a current multiple to take into account the cyclical variations of earnings.
• We use this terminal period to normalize the last year of projected free cash flow, and in turn, we use normalized free cash flow to calculate the terminal value via the Perpetuity Growth Method.
• However, obtaining data for private transactions may be easier said than done.

The two approaches for calculating the terminal value are the Exit Multiple Method and the Perpetuity Growth Method. The perpetuity growth rate is typically between the historical inflation rate of 2-3% and the historical GDP growth rate of 4-5%. If you assume a perpetuity growth rate in excess of 5%, you are basically saying that you expect the company’s growth to outpace the economy’s growth forever. In sum, this section has briefly discussed what exit multiples are, how we can apply them in the context of startup valuation, and what we have to keep in mind when using this valuation method.

Walk me through a DCF analysis interview question

For instance, if the cash flow at the end of the initial forecast period is $100 and the discount rate is 10.0%, the TV comes out to $1,000 ($100 ÷ 10.0%). The Terminal Value represents the estimated value of a company beyond the final year of the explicit forecast period, i.e. the Stage 1 cash flows. For example, suppose companies in the same sector as the company being analyzed are trading at, on average, five times EBIT/EV.

CFI is the official provider of the global Financial Modeling and Valuation Analyst (FMVA)® certification program, designed to help anyone become a world-class financial analyst. Multiples of publicly traded companies can be easily obtained from publicly dcf exit multiple available market data. However, obtaining data for private transactions may be easier said than done. 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.

Check Your Work

For this reason, DCF models are very sensitive to assumptions that are made about terminal value. For business valuation purposes, the discount rate is typically a firm’s Weighted Average Cost of Capital (WACC). Investors use WACC because it represents the required rate of return that investors expect from investing in the company. Implied Exit MultipleUsing the terminal value (not PV of terminal value), we can calculate the implied exit multiple range.

The 2020 EV/EBITDA of the identified comparable companies range from 6.6x to 21.7x. For the multiple based valuation, Centerview applies a multiple range of 11x to 17x to 2020 EBITDA. However, for the 2026 exit multiple in the DCF valuation the range is 13x to 18x. There are no explanations of the basis for determining the exit multiple range and whether it is based on the same 2020 multiples or a separate calculation of 2026 forward priced comparable company data. The objective of the comparable company analysis is to identify, for the company you are valuing, what multiple it is likely to trade on (based on expectations at the valuation date) at the end of the explicit forecast period. This means that the business dynamics or value drivers reflected in the multiples for the peer group should be consistent with those of the valued company at the start of the terminal period, not at the valuation date.

If so you might have to look a little harder (or get more creative) in your comp set selection. I know with the multiples method, you assume that a company will be sold for a certain multiple at the end of your projection period (let’s say it is 5. The best way to calculate the present value in Excel is with the XNPV function, which can account for unevenly spaced out cash flows (which are very common). Since the assumption is that the company will exit, the result is equivalent to an additional cash flow to the shareholders in the last forecasted year. A reasonable-seeming multiple relative to the industry average may not seem as reasonable if we examine the implied discount rate.

• The exit multiple method is ideal when investors want to assume a finite period of operations.
• When valuing a business, the annual forecasted cash flows typically used are 5 years into the future, at which point a terminal value is used.
• The forecast period is typically 3-5 years for a normal business (but can be much longer in some types of businesses, such as oil and gas or mining) because this is a reasonable amount of time to make detailed assumptions.
• For instance, if the cash flow at the end of the initial forecast period is $100 and the discount rate is 10.0%, the TV comes out to $1,000 ($100 ÷ 10.0%).
• The most commonly used multiple is EV/EBITDA, which is known as the enterprise multiple.

What you are referring to is a “foward EV/EBITDA” multiple which is pretty much never used because it depends entirely on your own inputs. So no, don’t use your projected EBITDA for your EV/EBITDA multiple…Use the LTM EBITDA for comparability’s sake when you do spread your comps. I suppose you could take out taxes, but then the starting point for comparable multiples you would use as a baseline would technically be EBIDA (never heard of using that though).