![]() ![]() Therefore, DCF should generally only be done alongside other valuation techniques, lest a questionable assumption or two lead to a result that is substantially different from what market forces are indicating. This leads to the concept of “ Garbage in = Garbage Out ”-if wrong assumptions are made, the result will be wrong.Īdditionally, DCF does not take into account any market-related valuation information, such as the valuations of comparable companies, as a “sanity check” on its valuation outputs. This is quite possible, given that DCF involves predicting future events (forecasting), and even the best forecasters will generally be off by some amount. If even one key assumption is off significantly, it can lead to a wildly different valuation. The valuation obtained is very sensitive to a large number of assumptions/forecasts, and can therefore vary over a wide range. However, DCF is fraught with potential perils. DCF is used by Investment Bankers, Internal Corporate Finance and Business Development professionals, and Academics. ![]() It is thus the most theoretically correct valuation method available: the value of a firm ultimately derives from the inherent value of its future cash flows to its stakeholders.ĭCF is probably the most broadly used valuation technique, simply because of its theoretical underpinnings and its ability to be used in almost all scenarios. Why use DCF?ĭCF should be used in many cases because it attempts to measure the value created by a business directly and precisely. NPV is simply a mathematical technique for translating each of these projected annual cash flow amounts into today-equivalent amounts so that each year’s projected cash flows can be summed up in comparable, current-dollar amounts. In a DCF analysis, the cash flows are projected by using a series of assumptions about how the business will perform in the future, and then forecasting how this business performance translates into the cash flow generated by the business-the one thing investors care the most about. WACC (Weighted Average Cost of Capital)ĭCF is a direct valuation technique that values a company by projecting its future cash flows and then using the Net Present Value (NPV) method to value those cash flows.In this Discounted Cash Flow chapter, we will cover four key topics: ![]()
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