Terminal multipliers

By Andrew Stotz | September 13, 2017

Estimation of terminal value of cash flows

We estimate the terminal value of cash flows by valuing the company as a perpetuity using the Gordon Growth model.This is done by defining terminal multipliers that take the final year’s cash flows and project them far into the future.We use two different terminal multipliers based on the valuation method that is used:

Terminal multiplier – DCF:
Terminal multiplier = 1/(WACC of non discrete period – terminal growth rate)
Terminal value = (final projected year’s cash flow * (1+terminal growth rate)) / (WACC of non discrete period – terminal growth rate)

Terminal multiplier – DDM:
Terminal multiplier = 1/(cost of equity – terminal growth rate)
Terminal value = (final projected year’s cash flow * (1+terminal growth rate)) / (cost of equity – terminal growth rate)

However, the Gordon Growth model has it’s limitations. It assumes a stable growth rate and has no room for deviations. Furthermore, if the required rate of return is less than the terminal growth rate, the result becomes a negative value and makes the model not applicable.

0 Shares