See below: One of the methods used when valuing a company is the DCF using perpetuity growth. This method determines a terminal value based on a perpetuity growth assumption in order to determine the price we should pay to buy a company.
However when calculating the IRR, we look at the price we paid (calculated above) versus a terminal value based on an exit multiple assumption for how much we expect to sell the company. My question is, can’t we determine the terminal value for IRR purposes using the perpetuity growth assumption like we do when calculating the price via DCF?
If so then since the exit multiple (for IRR purposes) tell us for how much we expect to sell the company as a function of EBITDA then what does the perpetuity growth assumption tell us when used for IRR purposes? This part is kind of tough, since we can’t sell the company for the assumed growth in EBITDA in perpetuity which I think will be the intuitive interpretation of calculating exit value using the growth rate for IRR purposes?
Any takers?
There is two parts to your question:
Adding to ElGranMono's straightforward and concise reply:
isnt the IRR predominantly used as a crucial metric within LBO scenarios? This makes the use of perpetuity formulas instead of exit multiples to calculate TV feel less intuitive. I mean you're typically betting on selling the company after a few years and it feels more natural to estimate exit multiples, which a potential buyer is willing to pay, rather than calculating a perpetuity that (for me at least) represents more of an intrinsic value assumption.
The problem is if you can;t estimate an exit multiple because of lack of com parables. It's also a good idea to calculate an IRR for an acquisition even if you are to hold in perpetuity, i.e reverse and see the outcomes if you were to sell.
Wouldn't it often be assumed as relatively similar to the entry multiple?
multiples give us a relative valuation indication vis-a-vis its peers. If an industry / company is "hot" we might expect it to expand its multiples in the coming years, if not its the way around. Our steady LBO candidate should be somewhere inbetween. I absolutely agree that there are no straightforward comparables for future exit multiples, but based on present multiples, in connection to the assumption that they will not change substantially due to the nature of the business / industry + reasonable multiple levels, there should be some validity right?
(im in no way an LBO expert so feel free to correct me where you see fit)
Thanks keeping the exit = entry multiple is good. However, due to the lack of comparables my entry multiple is very high. Currently at 12X!
That was a clever quick one for you El. Im sure im dead stupid!...lol
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