Which method can be used to calculate terminal value?

The terminal value represents the value of a business beyond the explicit forecast period, extending into perpetuity. It captures the bulk of a company's value in a Discounted Cash Flow (DCF) analysis. The Gordon Growth Model, also known as the Perpetuity Growth Model, is a popular method for calculating terminal value. It assumes that free cash flows will continue to grow at a constant rate indefinitely. This is particularly useful in scenarios where a firm is expected to grow at a stable rate in the long term.

The Exit Multiple Method, on the other hand, involves taking a financial metric (like EBITDA) at the end of the forecast period and applying an industry average multiple to estimate the terminal value. This method relies on exit multiples obtained from comparable transactions, making it a practical approach when valuing businesses in specific industries where comparable data is available.

Using both the Gordon Growth Model and the Exit Multiple Method allows for flexibility and can be tailored to the specific growth expectations and industry characteristics of the business being valued. It is essential for finance professionals to understand both methods, as they each provide different insights and can be utilized based on the unique context surrounding the business analysis.