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Approaches for Calculating the Terminal Value

Approaches for Calculating the Terminal Value

The terminal value can be calculated using a:

  • Single-stage (constant-growth) model.
  • Valuation multiples approach.

Under the valuation multiples approach, there are two ways this can be done.

$$\begin{align*}\text{Terminal value in year }n&=\text{Justified trailing P⁄E}\times\text{Forecasted earnings in year }n\\ \text{Terminal value in year }n&=\text{Justified leading P⁄E}\times\text{Forecasted earnings in year }n+1\end{align*}$$

Example: Estimating Terminal Value with a P/E Multiple

The EPS of a particular company is estimated to be $5.00 in five years. The EPS in six years is estimated to be $5.90. If the median trailing industry P/E is estimated as 28, the terminal value in year 5 is closest to:

Solution

$$\text{Terminal value in Year 5}=28\times\$5.00=\$140$$

Question

Given the following information,

  • \(\text{EPS}_{2019}=2.30\)
  • \(\text{EPS}_{2020}=3.00\)
  • \(\text{EPS}_{2021}=3.50\)

If the median trailing industry P/E in 2020 is estimated to be 32, the terminal value in 2020 is closest to:

  1. 73.6.
  2. 96.0.
  3. 112.0.

Solution

The correct answer is B.

$$\begin{align*}\text{Terminal value in year }n&=\text{Justified trailing P⁄E}\times\text{Forecasted earnings in year }n\\&=3\times32=96\end{align*}$$

Reading 24: Free Cash Flow Valuation

LOS 24 (l) Describe approaches for calculating the terminal value in a multistage valuation model.

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