I've got a simple question in TV, can someone explain why you are dividing by WACC-growth rate?
I understand the FCF*(1+g), but I'm having trouble understanding why you subtract g from the WACC (I understand the dividing by WACC).
Thanks I'm sure its a simple answer, I just dont see it right now
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It's actually not as simple as you might think, but its not hard either - it employs some well-known mathematical properties. If you are calculating your perpetuity by projecting cash flows from year 6 to infinity, the above eqn equals the value of all free cash flows into infinity discounted back to year 5. The equality involves the infinite sum of a series of numbers less than 1. It will be really hard to write it out on this msg board. If anybody wants, I'll make a PDF version of this eqns derivation and send it over. A necc. condition is that WACC > growth rate.
I have an explanation in pdf format. Let me know...
awesome! please email me ([email protected]) if you are willing to share ;)
thanks!!
thanks wordup, sent you a PM
can u sent it to me as well [email protected]
thanks
I feel like this is being explained in a more technical fashion than it needs to be.
A terminal value calculation deducts growth from WACC for the following reason: a single period's cash flow is being projected into perpetuity and then discounted at a constant rate (the WACC), so by applying a growth rate against this constant discount rate one can account for the fact that the initial cash flow (in the numerator) will grow at some constant rate over time (if the cash flow were to remain constant, there would be nothing to deduct from WACC in the denominator).
I think the technical way is good. It explains in a very concrete way what you're really doing when you use this equation: calculating the infinite sum of cash flows and discounting back to the present.
Well it’s certainly an elegant way of making a total wild-ass guess look more like a legitimate valuation methodology...
Terminal Value/EV- Perp Growth (Originally Posted: 10/23/2010)
So...
I have projected FCF's out to 2015 for a company.
For TV.
I take
((FCF Y2015*)1+terminal growth rate)/WACC-Terminal Growth Rate)
That is TV..
Then, I discount the above @ WACC to get PV of TV.
I then add this to the PV of CF's for years 2010-2014 to get EV.
Correct?
yes that is correct. EV as long as it's unlevered FCF.
Dont forget that:
((FCF Y2015*)1+Terminal Growth rate)/WACC-Terminal Growth Rate)
gets divided by the (1+discount rate)^Current Period - 2015
Obviously incorporating any mid-year conventions. A common mistake is to either not grow future CF for terminal value or to use the Terminal Period + 1 as the exponent on the Terminal Value discount back to PV. I've also seen people (people in college, not in the real world) just add the TV to sum of discounted operating CFs.
little confused there.........
I thought it was just discounted @ WACC?
so
TV/WACC. go get PV TV?
)
TEV= CF0 / (1+WACC)^1 + CF1 / (1+WACC)^2 + CF2 / (1+WACC)^3 + CF3 / (1+WACC)^4 + CF4 / (1+WACC)^5 + (CF5/(WACC-Perpetual_Growth)) / (1+WACC)^5
Where CF5 = CF4 * (1+Perpetual Growth Rate)
DCF Terminal Value Question (Originally Posted: 04/02/2013)
Why do you use an exit multiple to calculate terminal value? This makes no sense to me. I would think that it would make more sense to project a growth rate, then project free cash flow infinitely then take the sum of the total cash flow and discount it by WACC. And you wouldnt have to actually even project it infinitely, just until the net present value of the cash flow =~0
You can use a growth rate. What's the difference? Aren't both assumptions? Why would a growth rate be any more accurate?
Too many people out of undergrad (and even business school) rely on DCF and percentages as assumptions, rather than multiples. This is a perfect example.
If you actually think about it, the terminal multiple the a market-based approach of what the company is worth to potential acquirers (exit means shareholder exit). That is far more logical than talking about some ridiculous constant growth rate going to maturity.
You should've gotten him some burn heal. Damnnnnnn
i agree with what you're saying but then why even do a DCF at all? why not just a trading comps or precedent transaction analysis?
Exactly what I always ask professors when I talk to them at conferences or events. We rarely use DCFs and when we do, it isn't weighted nearly as heavy as Pub or Trans Comps.
Boss is a firm believer in the market and its appetite is what it is. Meaning, you can tweak a DCF all you want to get to say a $1 billion value. But, if the market is only willing to pay $750 million right now, what can you do about it?
Your options are to hold off on any sale until the multiples increase towards your DCF or sell at the price the market is willing to pay.
another question, after you get the implied perpetuity growth rate, what's the next step? Is the entire point of finding the perpetuity growth rate to find the correct EV/EBITDA multiple?
nvm, i figured it out
its more practical to use a terminal value because the volatility of FCF in the far future is irrelevant compared to it's smoothed growth trajectory.
read my recent post on multiples - multiples are just hidden DCF
put multiples have another advantage in being simpler and being able to model out acquisition exits (for an LBO possibly)
Lastly DCFs take several fundamental factors to compute an instrinsice value to be compared with market value fundamentals but multiples take market value and are tested against historical multiples and the fundamental factors then
You can see how mulitples are the correct and easier way to approach valuation then..
Terminal value issues (Originally Posted: 06/26/2010)
Hey Guys, what is the theoretical explanation why in the terminal value calculation we subtract the growth rate from the discount rate? I appreciate your help ! Tim
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