Comments (24)

Mar 4, 2010

Major disadvantage of the perpetual growth methodology is that it is difficult to estimate an accurate perpetual growth rate for a business. With the exit multiple methodology you can use precedent transactions to estimate the exit multiple at the end of the projection period (although in reality multiples can change drastically over the period).

It all comes down to the fact that you can better defend your assumption using an exit multiple approach. In most instances the terminal calc. will drive a good portion of the value in the model, so this assumption is important.

Mar 4, 2010

Also, the exit multiple method typically is greater than a perpetuity calculation, which leads to a higher company valuation.

Mar 4, 2010

both methods do not always concur

reality check: calculating the perpetual growth rate implied in the TV multiple:

g =

(TV Multiple * EBITDAn * WACC) - FCFn

/

(TV Multiple * EBITDAn) + FCFn

Mar 4, 2010

ALWAYS calculate both to check them against each other.

The pros and cons of each method depend on the quality of your forecasts and the information that is available to you.

Remember, multiples should be based on normalized multiples at the END of a company's projected horizon. In other words, select multiples from comparable companies that are similar today to what your company will look like at the end of your forecasted horizon.

If the business is assumed to be sold at the end of the projection period (i.e., LBO), the exit multiples should generally be based on "acquisition comps," as opposed to "trading comps" (i.e., should include a control premium)

If using the perpetuity growth method, the rate should be consistent with company's expected long-term industry growth rate, inflation rate, and the overall domestic and global economic growth rate (GDP). Remember, the perpetual growth rate cannot be higher than the GDP rate and cannot be lower than inflation.

Mar 4, 2010

Thank you all for your input, very helpful.

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Mar 4, 2010

they don't have any difference but one...

as people already pointed before, when you use a multiple, you imply growth. when you use growth, you imply a multiple. So essentially growth is the fundamental driver to both methods. 7x EBITDA multiple means nothing more and nothing less than a xx growth rate that will justify this multiple.

the reason why people talk more about exit multiples than growth is that it is easier to compare to the trading comps. people usually talk about companies trading at xx multiple rather than xx growth rate.

Mar 4, 2010

rmivalue:

Thanks for the info - out of curiosity I derived that equation myself and got a somewhat different result. Mind sharing how you arrived there?

Assuming: FCFn / (WACC - g) = (EBITDAn * TV Multiple)
FCFn = (EBITDAn * TV Multiple) * (WACC - g)
WACC - g = FCFn / (EBITDAn * TV Multiple)
g = WACC - FCFn / (EBITDAn * TV Multiple)

g = ((EBITDA * TV Multiple * WACC) - FCFn) / (EBITDAn * TV Multiple)

Same as yours but without a + FCFn in the denominator. Let me know if I missed something. Thanks!

Mar 4, 2010

Generally we show both methods in our valuation analysis at our firm. If you use the terminal multiple method, you will have an implied growth rate and vice versa.

Growth rate will be company specific. Easy way to find growth rate if you have no idea is to start with the terminal multiple method and back into an implied growth rate. exit multiples come from the comps. If the current forward EBITDA multiples are 7.0x then that would be your exit multiple. Obviously this multiple is subject to a lot of factors, but that is one way to get it.

To get a multiple for the comps you have to calculate EV (SEC Filings and Mkt. Cap info from Yahoo Finance) and some underlying EBITDA metric (estimates you can get from Thompson).

Mar 4, 2010

I'm pretty sure Yahoo finance uses Cap IQ info. Not sure how fresh it is tho, or how often it is updated.

Mar 4, 2010

During my internship, I used both. However, more merit was weighted towards the exit multiple method; this is what my MD said. Most of the companies that my boutique worked with were domiciled in North America so I used a perpetual growth rate of ~3% (GDP growth). If you are doing this to show interest, you can only utilize the resources you are given, right. So, use Yahoo finance for the multiples, but when you are projecting your CFs, you can just grow them at the 5-year CAGR.

The difference between successful people and others is largely a habit - a controlled habit of doing every task better, faster and more efficiently.

Mar 4, 2010

^ interesting. During my internship they definitely preferred perpetuity growth as opposed to exit multiple. Of course, it depends on the industry and stage of your company as well. Obviously perpetuity growth at GDP would make more sense for a utilities company than, say, a SaaS startup.

Currently: future psychiatrist (med school =P)
Previously: investor relations (top consulting firm), M&A consulting (Big 4), M&A banking (MM)

Mar 4, 2010

Thanks guys! I was also wondering how do you guys forecast changes in NWC y-o-y?

Mar 4, 2010
n1cktm:

Thanks guys! I was also wondering how do you guys forecast changes in NWC y-o-y?

A/R = A/R Days
Inventory = Inventory Days
Other Current Assets = % of Sales
A/P = A/P Days
Accrued Expenses = % of Sales
Other Current Liabilities = % of Sales

Total change Y-o-Y is your investment in NWC

    • 1
Mar 4, 2010

The assumption that the growth method is more conservative depends on your exit multiple assumptions. Why 3.0x? Seems quite low. Throw in something more in line with the market like 10.0x and then see what is more conservative.

    • 1
Mar 4, 2010

That makes a lot more sense - my exit multiple is probably just too low. Thanks for the suggestion AZ34.

Mar 4, 2010

Note that exit multiple varies by industry. Utilize precedent transactions to get a picture of where people in the industry typically exit.

Mar 4, 2010

3x is likely a very conservation exit multiple

Mar 4, 2010

If you were to forecast a consistent deflationary environment going off into perpetuity (forever) or a continuously strangled/stagnant business model then maybe, but i've never seen it.

Even if the business isn't going to grow materially, you can still grow it's nominal cash flow through inflation expectations.

Mar 4, 2010
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