Question

Briefly verbally describe the exit multiple method.

Briefly verbally describe the perpetuity growth method.

What is the limitation of both methods?

Answer 1

The exit multiple method:

An exit multiple is it refers to the terminal multiple at which any given project will be exited. It assumes that the project will be exited at the end of the projected period. It is computed by multiplying the exit multiple by the projected EBITDA or EBIT. Commonly used multiple is EV / EBITDA or  enterprise value/EBIT. If the comparable companies are trading at 3 times their EBIT, then the terminal value of the company in question is computed as 5 times of the average EBIT for the forecasted period.

the perpetuity growth model:

The Perpetuity Growth Model accounts for the value of free cash flows that continue growing at an assumed constant rate in perpetuity.

TV = free cash flow (1+g)/ (WACC - g )

Limitations of exit multiple method: A person must be prudent enough while using the Exit multiple method because multiples change over time.

this is a preferred method by investment bankers in valuation.

Limitations of perpetuity growth model:

The perpetuity growth model is limited by the difficulty in predicting an accurate growth rate. The multiples are dynamic in nature and they have a tendency to change over time. Any assumptions made in predicting the growth rate can also lead to inaccuricies in predicting the value as the growth rate cannot be the same rate for an infinite future period.

To overcome this limitation we should assume tat the business will grow at a stable rate in the future.