Terminal Value

Question 1

What is terminal value?

Answer 1

Estimated value of co beyond final year of explicit forecast period of DCF
CFGR and DR stay the same

Question 2

How do you calculate the Terminal Value?

Answer 2

• gordon growth method
• multiples method

Question 3

For the gordon growth method- what should the terminal UFCF GR be?

Answer 3

• should be below GDP of country
• dev markets usually 1-3%

Question 4

Why terminal UFCF GR so low?

Answer 4

growth always slows over time

Question 5

How does terminal UFCF GR differ from UFCF GR at end of forecast period?

Answer 5

close

Question 6

What is the formula for the multiples method?

Answer 6

Final Year EBITDA x Exit multiple

Question 7

What is the exit multiple?

Answer 7

TEV (Terminal Value) / EBITDA (final forecast year)
use gordon growth to find TV

Question 8

How do you derive the exit mult?

Answer 8

• comparable companies
• sometimes apply discount b/c mults tend to decrease over time

Question 9

How do you get UFCF ot Y1 of terminal period?

Answer 9

• project UFCF 1yr aft explicit forecast period
• last UFCF x (1 + Terminal UFCF GR)

Question 10

You’ve found TV. Now what?

Answer 10

• PV TV + PV UFCF = implied TEV
• implied EqV = Implied TEV + NOA - L&E items not from CS investors
• Implied share price = Implied EqV / diluted share count

Question 11

What do you check for?

Answer 11

• terminal FCF GR
• Terminal Mult

Question 12

How do you check if terminal FCF GR is correct?

Answer 12

• Get from both mtds and compare.
• Is it low enough? Has to be lower than GDP.

Question 13

How do you check if terminal mult (exit mult) is ok?

Answer 13

• pump into mults mtd
• how does it compare to median terminal mult of comps and current mult of co? should be in the middle

Question 14

Which mults to use for multiples method? Public comps or precedent transactions?

Answer 14

public comps, ideally 1-2 years in future
b/c don’t have control premium

Question 15

Why discount TV to PV?

Answer 15

• TV represents value at a pt in future
• valuation tells you what co is worth today so gotta discount

Question 16

What year do you use to discount the TV to PV?

Answer 16

the final year of the final forecast period

Question 17

Why use final year of forecast period to discount TV to PV? Shouldnt u use 1st year of TV?

Answer 17

Nope
- TV is PV of cash flows starting in TV
- but it’s the PV as of the end of the explicit forecast period

Question 18

Do you include unexercised options in DCF?

Answer 18

No. Small impact, tricky, not worth effort

Question 19

What is a more intuitive way to think about Gordon Growth formula?

Answer 19

Terminal Value = FCF in Year 1 of Terminal Period / (Discount Rate – Terminal FCF Growth Rate)

Question 20

What does the intuitive Gordon Growth formula mean?

Answer 20

• co is worth less if the Discount Rate is higher and worth more if the Terminal FCF
  Growth Rate is higher.
• The company is worth more when you have worse investment options elsewhere and worth less when you have better investment options elsewhere.

Question 21

Problem using TEV/EBITDA to calc TV?

Answer 21

• ignores Capex. 2 cos w similar TEV/EBITDA mults might hv v diff fcf and fcf growth figures -> implied values v diff

Question 22

Makes sense to use -ve Terminal FCF GR?

Answer 22

• expectation that co will stop generating CF eventually
• company isn’t worthless- just worth less

Question 23

What is an example of -ve Terminal FCF GR?

Answer 23

eg. biotech or pharma co and patent on key drug expires during explicit forecast period
- equals lost rev -? declining cash flow

Question 24

What assumptions to analyze in sensitivity table for DCF?

Answer 24

• things that make big impact in DCF- DR< Terminal FCF GR, Terminal Mult, key operational drivers that affect revenue growth, patent expiration on drugs if in pharma

Question 25

What is the most volatile part about DCF?

Answer 25

aka slight changes to what lead to large changes in NPV?
- WACC

If DCF projection is short and use exit multiple, exit mult will be more volatile than WACC

Question 26

What has more positive influence on terminal growth value in DCF- 1% decrease in DR or 1% increase in terminal growth rate?

Answer 26

• increase in terminal growth rate
• gordon growth formula

Question 27

How do you check TV if it’s accurate?

Answer 27

• pick a TEV/EBITDA terminal mult.
  Use DR, plug into gordon growth rate to find Terminal FCF Growth rate
  Is GR too high?