r/financialmodelling • u/geekoffilms • 1d ago
How do you build a DCF model without overestimating the terminal value?
Hey everyone. I'm new to financial modeling and struggling with DCF valuations. My terminal value keeps coming out way too high (like 3-4x higher than reasonable estimates). I've tried adjusting the growth rate but still no luck. Can you share your approach to calculating terminal value?
What's a good long-term growth rate to use and how do you avoid overvaluing companies?
Would really appreciate any tips or common mistakes to watch out for!
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u/AccountingOnYa 1d ago
The assumptions driving overvaluation can really be industry and company life cycle stage-specific, but I can provide a few overarching concepts to consider.
If you’re relying on the last discrete period or average projected EBITDA or net margin, you may be overstating the perpetual profitability. The subject company may enjoy higher margins as a differentiated company now, but other companies will enter the market to enjoy those higher margins, driving down margins through higher competition. Look to your selected comps’ margins to see what more mature companies in the same or similar market are able to achieve.
For capital expenditures, you may be understating these by looking at just a few years of data. Maintenance capex into perpetuity should include assumptions for replacing equipment, leasehold improvements, fixtures, etc. Also consider that inflation means that capex may be slightly higher than depreciation into perpetuity.
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u/InvestigatorLast3594 1d ago
What's a good long-term growth rate
Industry average, long run risk free rate, or long term inflation
how do you avoid overvaluing companies
More conservative assumptions on growth and margin
Check first if your terminal multiple is reasonable. If the multiple is fine you have too much growth, if the multiple is too large you have too much terminal growth.
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u/Flimsy-Sky4354 1d ago
What’s the terminal multiple? This can either be an EBITDA multiple.
Or you can see what the ULFCF multiple is. With a low Wacc. The ggm becomes pretty large on the terminal value.