In November, we wrote a post on the biggest mistake in a Discounted Cash Flow (“DCF”) model. There are, of course, a number of other mistakes (albeit smaller in comparison) that can creep into a DCF. And surprisingly, you would find these mistakes being  committed by amateurs and professionals alike. Yes, even investment bankers and equity research analysts don’t dot their i’s and cross their t’s!

In this post, we simply list out the top 10 mistakes and how to avoid them. Over the course of the next few weeks/ months, we’ll delve a little deeper into each to understand what the mistake is, its consequences and how we can correct for it.

So, here’s the list of the top 10 mistakes in a DCF:

DCF Mistakes

Note that we are not suggesting that you will arrive at the “accurate” value of the firm simply by correcting for the above. After all, the intrinsic value of a company is a range and it would be foolhardy to believe that one can come up with a precise value. However, correcting for these mistakes will allow you to take control of your DCF and be certain that there are no fundamental mistakes in it. It can then allow you to concentrate on testing your assumptions for reasonableness and spend more time on refining them.

Have you come across any mistakes in your work other than those listed above? Let us know and we’d add them to our list.

 

4 thoughts on “Top 10 mistakes in a DCF

  1. Can I just ask what is wrong with using government bond yields as the risk-free rate especially in the context of American stocks where the probability of default is almost 0?

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    1. Brandon,

      With US stocks its ok to use the T-Bond rate as the risk free rate. The point is that not all government’s are risk free and what may be risk free today may not remain risk free in the future. Thus, it is important to understand why government bond yields may not be the correct risk free rate to use in some cases.

      Regards

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      1. Hi Brandon,

        I don’t have a video tutorial for estimating risk free rates but, you can refer this snapshot which lists out the steps in coming up with a risk free rate for an emerging market country (i.e. a country which is not default free).

        https://wp.me/p3FB5n-e5

        Let me know if you have any questions and I’ll be happy to answer them.

        Hope this helps.

        Shashank

        Like

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