If you use an exit multiple to estimate the terminal value of a set of cash flows or dividends, to what extent does the multiple you choose have to match the type of cash flows in the prior discrete years?
For example, you can value years 1-4 using DDM and then using a P/E multiple to estimate the terminal value. However, the discrete years are solely based on dividends while the terminal is based on total earnings, does this matter? I can’t think of any mutliple of dividends that you might use. I realize you shouldn’t use, say, EBITDA bc then you have a difference in equity and total firm cash flows.
Another example, say you use FCFF to value a firm, would you have to use a mutliple of FCFF or can you use an EBITDA multiple even though it’s not the exact same cash flow measure?
Using a GGM seems cleaner bc you are using the exact same measure of cash flows as the prior years in order to determine the terminal value.
the terminal value can be determined either using the Gordon growth model or by multiplying the company’s earnings or sales forecast by the benchmark value of a comparative multiple. It doesnt matter if you use a different method to estimate values befores maturity level ( ie terminal value)
hey, good question
quick answer to this question, is it doesn’t matter what you use, but you must value the equity for an equity model.
for instance, in a DDM with a terminal value using a P/E multiple, you can assume that you will sell the stock at the end of the 5 years. so the terminal value will be what the stock is worth at the end of the five years and this is your final cash flow.
so if you think you will receive $1 in dividends for the next 4 years and the stock will be worth, based on forecasted P/E multiple say $20, just count this $20 as the final sale of your investment and hence the final cash flow, then discount it back to today
cheers!