Gordon growth model vs. exit multiple — which terminal value method should I use?

Terminal value (TV) typically represents 60-80% of a company's total DCF value, so this choice matters enormously. Here are both methods and their trade-offs.

Method 1: Gordon Growth Model (Perpetuity Growth)

TV = FCF_n × (1 + g) / (WACC - g)

Assumes free cash flow grows at a constant rate forever after the explicit forecast period.

Strengths:

• Theoretically sound for stable, mature businesses
• Does not rely on comparable companies
• Forces you to think about long-term fundamentals

Weaknesses:

• Extremely sensitive to g (terminal growth) and WACC
• Assumes a perpetuity, which may be unrealistic for many businesses
• g must be ≤ long-term nominal GDP growth (otherwise the company overtakes the economy)

Method 2: Exit Multiple

TV = EBITDA_n × Exit Multiple (or Revenue_n × Exit Multiple)

Assumes the company is sold at the end of the forecast period for a market-based multiple.

Strengths:

• Grounded in observable market data
• Easier to benchmark against current trading multiples
• Less sensitive to a single growth assumption

Weaknesses:

• Relies on current market conditions (multiples may be elevated or depressed)
• Circular reasoning if used alongside comparable analysis
• Assumes comparable companies exist at the terminal date

Example — Horizon Robotics DCF:

• FCF in Year 5: $80M
• WACC: 10%
• Terminal growth: 2.5%
• Year 5 EBITDA: $120M
• Peer average EV/EBITDA: 12x

Reconciliation approach:

1. Calculate TV using both methods
2. If they differ significantly, investigate why:

• Is the exit multiple implying an unreasonable growth rate? Back-solve: g = WACC - (FCF/TV) = check if it's realistic
• Are current comparable multiples at a cyclical peak/trough?

1. Use the average or the method more appropriate for the business

Best practice: Present both in your analysis, explain the assumptions behind each, and let the reader see the range. Many professionals use Gordon Growth as the primary method and cross-check with exit multiples.

Exam tip: CFA Level II may ask you to calculate terminal value using both methods and explain why they differ. Know the implied growth rate formula to back-solve from an exit multiple.

Practice terminal value calculations in our CFA Level II course.