WACC Assumptions and Problems
Assumptions: Risks of cash flows do not change over time. Company maintains a steady capital structure. Problems: Often a constant discount rate is inconsistent with projected changes to capital structure, caused for instance by: Leveraged Buyouts Planned M&A activity Future stock buy-back plans
DCF Valuation approach is easiest to use for assets (firms) whose...
cash flows are currently positive cash flows can be estimated with some reliability for future periods proxy for risk is available
DCF Valuation works best for investors who either...
have a long time horizon, allowing the market time to correct its valuation mistakes and for prices to revert to “true” value are capable to move price to value
Advantages of DCF Valuation
less exposed to market moods and perceptions. forces you to think about the underlying characteristics of the firm, and understand its business.
Disadvantages of DCF Valuation
requires far more inputs and information inputs can be manipulated no guarantee that anything will emerge as undervalued or overvalued.
