Implied terminal growth
DCFThe perpetual growth rate an exit multiple is assuming, found by solving the perpetuity formula backwards at your discount rate.
Also written: implied perpetuity growth, implied growth rate
An exit multiple imports a number from the market without saying what it assumes. Setting the multiple based terminal value equal to the perpetuity formula and solving for g extracts the assumption, and the answer is testable against a macro ceiling in a way the multiple itself is not.
The algebra is short. Terminal value equals terminal cash flow times one plus g, over WACC less g. Multiply out, collect the g terms, and g equals the terminal value times WACC, less the cash flow, all over the terminal value plus the cash flow.
What the answer means depends on which side of the bounds it lands. Above long run nominal GDP in the currency of the cash flows, the multiple is too generous whatever the comps show. Deeply negative, and either the multiple is too low or the terminal year earnings are not representative of the steady state.
The check has one prerequisite that is easy to miss: the cash flow and the earnings figure must come from the same year and the same definition. Solving with a terminal year cash flow against a multiple applied to a different year produces a number that means nothing.
Worked example
Comparable companies trade at 10.0 times, and terminal year EBITDA is 200, so the terminal value is 2,000. Terminal year free cash flow is 96 and the WACC is 9%.
Solve 2,000 times 0.09 less g equals 96 times one plus g. That gives 180 less 2,000g equals 96 plus 96g, so 84 equals 2,096g, and g is 4.0%.
Euro area long run nominal GDP is nearer 3%, so the multiple is asserting perpetual growth the economy cannot support. Either the terminal year cash flow is understated or the comp set is wrong for this business.