Which methods can be used to estimate terminal value in a DCF?

Which methods can be used to estimate terminal value in a DCF?

• A. Gordon Growth model and exit multiple
• B. Gordon Growth model only
• C. Exit multiple only
• D. None

Answer: (A)

Terminal value in a DCF can be estimated using either the Gordon Growth model or an exit multiple. The Gordon Growth model treats cash flows as a perpetuity that grows at a constant rate forever, with the terminal value calculated as TV = FCF1 / (WACC − g), where FCF1 is next year’s free cash flow, WACC is the discount rate, and g is the perpetual growth rate. This approach is appropriate when you expect the business to continue indefinitely with stable growth. An exit multiple uses a market-based valuation: you apply a multiple (derived from comparable companies or precedents) to a terminal metric at the end of the projection period, such as EBITDA or revenue. This reflects how similar firms are valued in the market and is useful when there’s reliable market data or when a sale at the end of the projection is a reasonable assumption. Both methods are standard tools for estimating terminal value, and practitioners often compare them or use both to cross-check results.

Terminal value in a DCF can be estimated using either the Gordon Growth model or an exit multiple. The Gordon Growth model treats cash flows as a perpetuity that grows at a constant rate forever, with the terminal value calculated as TV = FCF1 / (WACC − g), where FCF1 is next year’s free cash flow, WACC is the discount rate, and g is the perpetual growth rate. This approach is appropriate when you expect the business to continue indefinitely with stable growth.

An exit multiple uses a market-based valuation: you apply a multiple (derived from comparable companies or precedents) to a terminal metric at the end of the projection period, such as EBITDA or revenue. This reflects how similar firms are valued in the market and is useful when there’s reliable market data or when a sale at the end of the projection is a reasonable assumption.

Both methods are standard tools for estimating terminal value, and practitioners often compare them or use both to cross-check results.