What are the most common assumptions in DCF analysis?

The pivotal assumption in the Discounted Cash Flow (DCF) valuation analysis centers around the sales growth rate, representing the forecasted earnings of a company in the upcoming years before transitioning to the terminal growth phase, typically projected over 3 to 5 years. This growth rate is intricately linked to various factors, including historical growth patterns, industry-wide growth rates, and comparable company performance. Additionally, it can be derived by estimating the maturity rate of a leading competitor in the industry that has already reached maturity. For the forecasted period, this growth rate can be evenly distributed based on the last actual revenue growth.

In unidimensional planning, the revenue growth rate is a substantial factor. Not just expressing prosperity towards the market in selling the company's products. Often, margins and cost ratios are estimated relative to revenue - so there is an interdependency. The impact of the revenue growth rate can be better understood by including sensitivity analyses, computationally varying for one or several factors. Instead of a unidimensional planning, scenarios could also be implemented (e.g., low-, base-, high-case), covering specific anticipated developments.

There are generally two ways around revenue forecast. For most companies, revenue is simply a function of sales volume multiplied by price per unit of product/service. Hence, the first approach is a bottom-up forecast of potential unit sales volume and price trajectory. For volume, observe past trends and see if there is a pattern, taking reference from industry projections if any. For the unit price, one can either make an estimate based on the company's pricing strategy (for e.g., premiumization), or incorporating the level of pricing needed to stay relevant in a competitive market. On the other hand, another common approach is to estimate the overall industry revenue, and assuming the % that the company can capture over time.

Operating margin follows from planning/estimating revenue and operating expenses. It is specific for the company, however should be assessed with industry and competitor numbers. Be aware of any hockey-stick planning, that leads to abnormally high margins - I would take a critical look, if I'd see annual operating margins that are lastingly and substantially higher than those of benchmarks.

The discount rate (cost of capital, wacc) should not be an assumption at all. It can be derived from the earning risk of the valuation object (e.g. coefficient of variation of the cash flow) and the return-risk profile of the available alternative investment options (such as government bonds and stock market index). It expresses what return would be expected in the alternative investments with the same risk. Therefore, if possible, a risk analysis should be carried out as a basis for information.

Define, which technical level the valuation should fulfil. Typically, for M&A purposes, industry cost of capital are applied, which are consistent over time. Be aware, however, that this is a simplification. More technical rigor, e.g., would include consistency in the type of discounted cashflow and the corresponding discount rate, the calibration of the peer group and the discount rate, annual un- and re-levering etc.

After three to five years of detailed planning, typically a transition into the terminal value (TV) is applied. The TV makes up a substantial amount of the overall company value. Depending on the sustainability of the business model and the industry, this could even be substantially more than 100 % (e.g., when there are initial losses; consider start-ups vs. established companies; consider artificial intelligence vs. tobacco companies).

From a cash flow perspective, it is usually about the periodical change in working capital, rather than the absolute values. Some may find it difficult to grasp the directional impact of working capital changes on the cash flow statement. To understand this, one simply has to recognize that a decrease in assets is similar to you selling the assets, thereby converting them into cash. Vice versa when your assets increase. On the liability side, think of it as additional money that you will receive as you increase your borrowings (a type of liability). Repayment (a decrease) has the reverse effect. This logic would serve you well in the case of WC changes in assets (inventory and account receivable) and liability (account payable).

As always, as this concern financial modeling: - Be aware of the data you are using for your inputs. "Bullshit in, Bullshit out". This is true for cashflow estimates as well as capital market data included in the discount rate. - U N D E R S T A N D what the models do and what the explicit and implicit assumptions mean! A company valuation is essentially a present value, so from a computational/technical point of view, this isn't rocket science. Penetrating the valuation, however, is a real plus for your clients, in my experience.

Ciclo de Vida do Produto ou Empresa Defini??o: O estágio do ciclo de vida em que o produto ou empresa se encontra. Impacto: Empresas em estágios iniciais podem ter maior potencial de crescimento, mas também maior incerteza.