Wednesday, 4 March 2015

DCF: Hall of Shame (1)

Interesting article from Professor Aswath Damodaran:

"DCF Myth 1: If you have a D(discount rate) and a CF (cash flow), you have a DCF!"

He defines "the consistency test" for DCF:
  • Unit consistency
  • Input consistency
  • Narrative consistency
And continues:

"Many of the DCFs that I see passed around in acquisition valuations, appraisal and accounting  don’t pass these consistency tests. In fact, at the risk of being labelled a DCF snob, I have taken to classifying these  defective DCFs into seven groups:"

Followed by the seven DCF groups and their description. The following picture gives some insights:

From the above we can see that there are many pitfalls in making a correct DCF. That is a serious problem with DCF.

But I think there is an even larger problem: dishonesty from the side of the DCF modeller. In the Malaysian context (and may be even in the global context), that is in my opinion a huge problem.

I will detail my reasons for this in a subsequent posting.

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