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The 1.7-Turn Terminal Value

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The 1.7-Turn Terminal Value

You are valuing a packaging distributor for a sponsor. The DCF covers 2024E-2028E; the present value of explicit free cash flow is $141m, 2028E EBITDA is $120m and 2028E unlevered FCF is $75m. WACC is 9.5%, perpetuity growth 2.5%, and the exit multiple applied to 2028E EBITDA is 7.5x, the median of five recent transactions. Net debt is $340m and there are 90m diluted shares. The associate's memo, which averages the two terminal value methods 50/50, shows enterprise value of $776m and equity value per share of $4.84. The sponsor's investment committee clears the deal by a thin margin, and the memo is due Friday.

1. Compute the EV/EBITDA multiple implied by the perpetuity growth method and explain what the gap to the 7.5x exit multiple tells you.

Read the worked answer
  • Perpetuity TV: 75 x 1.025 / (0.095 - 0.025) = 76.875 / 0.07 = $1,098m.
  • Discount factor: 1.095^5 = 1.5742, so PV = 1,098 / 1.5742 = $698m.
  • Implied multiple: 1,098 / 120 = 9.2x 2028E EBITDA.
  • Exit multiple TV: 7.5 x 120 = $900m, PV = $572m.
  • The gap is a diagnosis, not an average. Two methods that are 1.7 turns apart on the same EBITDA are telling you one input set is wrong. A 50/50 blend is the one response that hides the information.
  • What usually bridges it: (a) the comp set - five transactions of unknown vintage, likely small and illiquid, so 7.5x may be stale; (b) the discount rate - 9.5% for a levered distributor with cyclical end markets may be too low, which mechanically inflates the perpetuity multiple; (c) the growth rate - 2.5% is a nominal-GDP assumption pinned onto a business whose share trend you have not tested.
  • Sanity test worth running: 9.2x for cash flows growing 2.5% discounted at 9.5% is internally consistent - it is not an arithmetic error. The error, if any, is in the inputs, and the partner needs to know which one.

2. What perpetuity growth rate would make the two terminal values agree, and how does that answer change your view of which method is the outlier?

Read the worked answer
  • Set the perpetuity TV equal to the exit multiple TV: 75 x (1+g) / (0.095 - g) = 900.
  • 75 + 75g = 85.5 - 900g, so 975g = 10.5 and g = 1.08%.
  • Interpretation: to agree with 7.5x, long-run growth has to fall to roughly 1.1%. If the defensible long-run assumption is 2.0-2.5% (inflation plus modest real growth), then the exit multiple is the outlier, not the perpetuity.
  • Check the other direction: at g = 1.5%, TV = 76.125 / 0.08 = $952m, an implied 7.9x. At g = 2.0%, TV = 76.5 / 0.075 = $1,020m, an implied 8.5x. So across the whole defensible growth range the perpetuity implies 7.9-8.5x, still above 7.5x - the gap is not caused by the 2.5% assumption alone.
  • Where to look next: five-year revenue CAGR, the price/volume split, and whether the comps were struck at a different point in the cycle. If the growth evidence supports 2%+, the exit multiple is too low and the deal may be undervalued; if growth is genuinely ~1%, the perpetuity assumption is the aggressive one and the associate has been overpaying.

3. What should the memo actually say, and what do you tell the partner before Friday?

Read the worked answer
  • State the fragility first. TV is roughly 82% of EV ($635m of the $776m). Essentially the entire equity value is a terminal-value bet.
  • Quantify the sensitivity. A 50bp move in WACC swings the perpetuity PV by about $48m - roughly $0.53 per share, or 11% of the $4.84 equity value per share. A 50bp change is inside any reasonable WACC range.
  • Recommendation: present perpetuity growth as the primary method with g at 1.5-2.0%, use the exit multiple as a floor cross-check rather than an equal partner, and disclose the implied exit multiple that the chosen growth rate produces (7.9-8.5x). Do not show a 50/50 blend as a point estimate.
  • The IC point: a deal that clears the return threshold only because of the terminal assumption has not cleared the threshold - it has cleared a scenario. The honest framing is 'returns are met at g of 2%+ and 9.5% WACC, and fail at 8.0x exit and 10.0% WACC'.
  • Action before Friday: refresh the comp set or explicitly caveat its vintage, and tell the partner the deal's clearance rests on a terminal assumption that sits 1.7 turns above the transaction evidence.