Question

Discounted cash flow approach

The discounted cash flow (DCF) approach is the preferred approach for valuing a business because it includes a detailed analysis of key forecast and valuation variables. However, in reality, there are some practical issues that limit the applicability of this approach.
Common issues include the lack of a regularly prepared forecast and the unreliability of the information contained in such a forecast.

a) DCF is always reliable.
b) DCF is rarely used in business valuation.
c) DCF includes unreliable information.
d) DCF is not a preferred approach.

Answer 1

The DCF approach is used for business valuation by comparing present costs to discounted future benefits, but it can be unreliable due to forecasting inaccuracies and rate selection challenges.

Step-by-step explanation:

The Discounted Cash Flow (DCF) approach is a financial model used for valuing a business by forecasting its cash flows and discounting them to the present value. However, the DCF method may include unreliable information which can limit its applicability. The prediction of future cash flows is not always accurate, and the selection of an appropriate discount rate can be challenging. These factors contribute to the uncertainty in the DCF approach, highlighting a practical issue that it is not always completely reliable. Instead, it's an analytical tool that compares present costs to the present discounted value of future benefits, commonly used in various financial decisions, such as capital investments, bond valuations, and assessing environmental policies.