Intuition behind using P/E Multiple for TV
Hi All,
For an upcoming modeling test I have a question that hasn't really been answered here I believe.
I am required to build a DCF Model and got some pretty standard assumptions to work with. However, one of the assumptions tells me to calculate the terminal value using a given P/E multiple.
What is the intuition behind calculating terminal value using the P/E multiple? What implications does this have for my dcf (any different steps I need to take or things I need to consider) ?
Thanks!
Interested in this as well. To get net income of the final year in the forecast period, would we have to project interest expense as a % of revenue? It seems like WACC assumes a constant debt to value ratio, so is it correct to say that it wouldn't be possible to forecast debt in the final year to calculate interest expense (otherwise we would have to already know the value of the firm)?
I was thinking about doing the following:
Projecting the income statement through net income (calculating interest expense assuming debt stays the same, = avg historical interest expense as percentage of debt and keeping it constant). Calculating the present value of FCF during the projection period using WACC as normal. For the TV, multiply P/E with EPS (using net income projections + constant # shares outstanding), subsequently discount this value using the CoE. Afterwards, calculate the value of interest tax shield in terminal period (= tax shield / CoD) and calculate the PV using CoD. This gives you the Enterprise Value, from here follow the standard steps to arrive at Equity Value.
Thoughts?
I'm just a prospect, so obviously I don't know much about this stuff. But as an easier alternative could you use just levered FCF for the projected years, so that way you can just go straight to equity value?
These two answers are on the right track. I’m not fully sure of the parameters of this model, but it appears that they may be looking for Equity Value through the DCF. In that case, you would use Levered Free Cash Flow, which is the cash flow available to equity holders. You would then discount these cash flows using CAPM (assuming the capital structure stayed relatively constant throughout the forecast horizon). If they provided a P/E on exit, then just arrive at your year 5 (or 10 or whatever it is) net income and multiply it to finish it out.
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