Terminal Value: Gordon Growth vs Exit Multiple

Gordon growth formula

Use the next period’s sustainable free cash flow, not automatically the last explicit forecast cash flow. The discount rate must exceed perpetual growth. Continuing reinvestment, margins and taxes must support the growth rate.

TV at year n = FCF_(n+1) / (r − g)
If steady-state assumptions apply: FCF_(n+1) = FCF_n × (1 + g)

Worked perpetuity example

Final-year FCF is $5m, long-run growth is 2% and WACC is 10%. Terminal value is $5m × 1.02 / 8% = $63.75m. At the end of year five its present value is $63.75m / 1.1⁵ = $39.58m. If WACC falls to 9%, terminal value rises to $72.86m before discounting, illustrating sensitivity.

Exit-multiple formula

Apply an enterprise-value multiple to an enterprise-level metric. State whether the multiple uses final historical/forecast earnings or forward earnings. Exit EV is not exit equity proceeds until debt, cash and other claims are reconciled.

Exit EV = Terminal EBITDA × exit EV/EBITDA multiple

Worked exit-multiple example

At $12m terminal EBITDA and an 8.0x multiple, exit EV is $96m. With $25m debt and $4m eligible cash, simplified equity proceeds are $75m before fees or other claims. An 8.0x exit multiple is an assumption requiring support, not a fact implied by the model.

Timing and comparability

Discount the terminal value from the date at which it is defined. A mid-year convention for explicit cash flows does not automatically determine terminal timing. Compare the implied terminal EV/EBITDA multiple from Gordon growth with comparable economics, and examine whether the exit multiple implies an implausible perpetual growth rate.

Common errors

Do not use g greater than or equal to the discount rate, capitalize an unsustainable cash-flow spike, or add forecast cash accumulation twice. In diophos, DCF and APV use continuing-value assumptions while Exit Multiple uses the selected exit earnings multiple. Run downside sensitivities rather than relying on one terminal assumption.