Hi guys. Don’t you think it is more reasonable to use different discount rates for each cash flow in DCF valuation? Motivations: 1) Risk-free rate (used in CAPM) should be different for each cash flow and should be determined by T-security with respective maturity. 2) More distant cash flows are more uncertain therefore there is more risk in distant cash flows. 3) Equity-Debt blend is very probable to change, affecting D & E weights in WACC. 4) If this is a start-up project then on the contrary the early stages cash flows should be considered more risky.

cfa_moscow Wrote: ------------------------------------------------------- > Hi guys. Howdy. > > Don’t you think it is more reasonable to use > different discount rates for each cash flow in DCF > valuation? Yes. > Motivations: > 1) Risk-free rate (used in CAPM) should be > different for each cash flow and should be > determined by T-security with respective > maturity. Yes. > 2) More distant cash flows are more uncertain > therefore there is more risk in distant cash > flows. No, compounding takes care of this already. > 3) Equity-Debt blend is very probable to change, > affecting D & E weights in WACC. If necessary switch to APV. > 4) If this is a start-up project then on the > contrary the early stages cash flows should be > considered more risky. Yes.

…and, to follow up: wacc is a hack for the lazy. If you have reliable (even if subjective) probabilities for future cash flows, use those to adjust the expected flow amount and then discount at risk-free rate. This would particularly address your #4.

DarienHacker Wrote: ------------------------------------------------------- > cfa_moscow Wrote: > -------------------------------------------------- > ----- > > Hi guys. > > Howdy. > > > > > Don’t you think it is more reasonable to use > > different discount rates for each cash flow in > DCF > > valuation? > > Yes. Agreed, but there comes a point where different discount rates add little to the final outcome. What matters most in a DCF valuation is the terminal value. It captures most of the value of the firm in one number and also happens to be the hardest thing to quantify. > > > Motivations: > > 1) Risk-free rate (used in CAPM) should be > > different for each cash flow and should be > > determined by T-security with respective > > maturity. > > Yes. > > > 2) More distant cash flows are more uncertain > > therefore there is more risk in distant cash > > flows. > > No, compounding takes care of this already. Not so. A DCF analysis attempts to determine the future cashflows, which are highly dependent on the variables in your model for that given period of time. Those variables and the circumstances around them determine the relative risk of the venture, which in turn leads to higher rates. Also, the discount factor on a flat curve will be declining, regardless of the fact that the ‘risk’ is the same. > > > 3) Equity-Debt blend is very probable to > change, > > affecting D & E weights in WACC. > > If necessary switch to APV. > > > 4) If this is a start-up project then on the > > contrary the early stages cash flows should be > > considered more risky. > > Yes. Agreed, but in my opinion, DCF analysis is a very limited tool when valuing a start-up. It may be more meaninful (if not more esoteric) to value a start-up as a series of binary options in the short term and only once the startup is in a steady state growth mode can you apply a more meaningul DCF analysis.