As interest rates decline, what generally happens to the terminal multiples for industry sectors?

When interest rates decline, it generally results in an increase in terminal multiples for industry sectors. This relationship can be attributed to several economic factors.

Lower interest rates reduce the cost of borrowing, making it cheaper for companies to finance expansion and capital projects. This increased access to capital can lead to improved profitability and growth prospects, which investors often value more highly. Consequently, the expectation of higher future cash flows tends to attract investors, driving up the multiples they are willing to pay based on those forecasts.

Additionally, as interest rates fall, the discount rate used in calculations of present value also decreases. A lower discount rate increases the present value of future cash flows, thereby elevating the terminal multiples. This reflects a higher valuation placed on future earnings, as investors are more willing to pay a premium when capital is cheaper and growth is encouraged.

In summary, the interaction of declining interest rates and investor sentiment – expecting better growth and returns – leads to an increase in terminal multiples across various industry sectors.