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What the interviewer is testing
Whether you know both methods and their formulas, when each fits, how to cross-check them, and why terminal value assumptions drive so much of a DCF.
Answer framework
- Define it: the value of cash flows beyond the projection period.
- Gordon Growth: final-year FCF x (1 + g) / (discount rate - g).
- Exit multiple: final-year EBITDA (or another metric) x a multiple from comparable companies.
- Discount it back to today from the end of the projection period.
- Cross-check the two methods and show sensitivity tables.
Sample answer
Terminal value captures the value of cash flows beyond the projection period. With Gordon Growth it is final-year free cash flow x (1 + long-term growth rate) / (discount rate - growth rate). With an exit multiple it is final-year EBITDA, or another metric, x an exit multiple from comparable companies. Either way I discount it back to today from the end of the projection period.
Exit multiple is common in banking because it ties to market valuations and to how buyers think about exits. Gordon Growth suits mature, stable businesses and is preferred when there are few good comparables or market multiples are distorted. Best practice is to cross-check: compute the growth rate implied by the exit multiple and the multiple implied by the growth rate.
Terminal value is often the majority of a DCF's value, so sensitivity tables on its inputs matter. The long-term growth rate should not exceed long-run nominal GDP growth.
Likely follow-ups
Common mistakes
- Forgetting to discount the terminal value back to today.
- Using a growth rate above long-run nominal GDP growth.
- Applying an exit multiple without checking the growth rate it implies.
- Treating the output as precise when most of the value sits in the terminal value.
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Related questions
Based on questions #30, #31, #50 in the full question bank.