What are the two common approaches to calculate terminal value?

The two common approaches to calculate terminal value are Growth in Perpetuity and Exit Multiple.

The Growth in Perpetuity method assumes that a business will continue to generate cash flows at a stable growth rate indefinitely. This approach calculates terminal value by taking the expected cash flow in the final forecast year, growing it by a perpetual growth rate, and then discounting it back to present value. This is particularly useful for businesses with stable, predictable growth.

On the other hand, the Exit Multiple approach estimates terminal value by applying a market multiple (such as EBITDA or revenue multiple) to the financial metrics of the company in the final forecast year. This method is often used when there are ample comparable companies or transactions from which to derive an appropriate multiple, reflecting how the market values similar businesses at the end of the projection period.

Both approaches provide a way to estimate the value of a business beyond the explicit forecast period and are widely accepted in financial modeling and valuation practices.