What method is commonly used to estimate the terminal value in a DCF model?

The method widely used to estimate the terminal value in a DCF model includes the Gordon growth model and the exit multiple method.

The Gordon growth model, also known as the perpetuity growth model, assumes that cash flows will continue to grow at a stable rate indefinitely after a certain projection period. This model is particularly useful for valuing companies with stable growth rates, as it accounts for future cash flows in perpetuity, discounted back to present value.

On the other hand, the exit multiple method estimates terminal value by applying a multiple to a financial metric, such as EBITDA or revenue, at the end of the forecast period. This method is grounded in the idea of how similar companies are valued in the market at a specific point in time, thereby providing a market-driven approach to value estimation.

Both methods are fundamental in DCF analyses as they provide a way to capture the value of a business beyond the explicit forecast period, ultimately contributing significantly to the overall valuation derived from the DCF model. The flexibility and applicability of these methods to various scenarios make them central to terminal value calculations.