Terminal Value: Why FCF(n) for Exit multiple and FCF(n+1) for Gordon Growth

Maxcmus's picture
Rank: Chimp | banana points 14

Hi Everyone,

I am struggling with understanding how TV is calculated with the exit multiple vs gordon growth method, and I hope someone can help.

Assuming I have projected out FCF for year 1 to 5, the Exit multiple method suggests to take the FCF (or EBITDA or EXIT) of year 5 and multiply it with a corresponding multiple of comparable companies. The Gordon Growth method suggests to take the FCF for year 6 and divide it by (r-g)^6.

Why does the "n" of the numerator differ for both methods? Why do we use FCF (n+5) for Exiting multiple and FCF (n+6) for Gordon Growth?

Thanks!!
Max

Comments (3)

Dec 28, 2018

With Gordon growth you discount with the rate used in last year of your forecast, so year 5 instead of year 6 in your example. Look on youtube how perpetuity formula is derived and why FCFy6 is in the denominator (or actually FCFy5 * (1+g)).

If you understand valuation however, you don't use gordon growth formula for your terminal value but value driver method.

Dec 28, 2018

Oh! Thanks so much! What an eye-opener!

Dec 28, 2018
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