What is a significant drawback of using EV/EBITDA multiples to estimate terminal value?

Utilizing EV/EBITDA multiples to calculate terminal value does indeed have significant drawbacks, and one of the main concerns is that these multiples can provide a misleading representation of free cash flows. EBITDA, which stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, is a measure of a company’s overall financial performance and indicates its operational profitability. However, it is important to recognize that EBITDA does not account for capital expenditures, working capital needs, or taxes, all of which can substantially impact a company's ability to generate free cash flow.

When relying solely on EV/EBITDA multiples, analysts might overestimate the company's terminal value since they ignore these critical factors that can affect cash flow. This can lead to unrealistic valuations, especially if a significant amount of capital expenditure is required for future growth, or if a company has high levels of debt which would affect its free cash flow position.

Thus, while EV/EBITDA is a useful metric for certain comparisons, using it to estimate terminal value without considering the broader financial context can yield skewed results when evaluating a firm's long-term worth.