Common Mistakes in Valuation (Discounted Cash Flow)

Financial Modelling is both an art and science as it is not only based on Corporate Finance Theory but also on the ability of the Analyst to put theory in practice. This articles describes some common mistakes in Discounted Cash Flow (DCF) valuation, the principal method for valuing a business. Suggestions have been made to deal with these errors in three levels of DCF valuation: WACC calculation, Free Cash Flow calculation in previous periods as well as in the projected period and other common financial modelling mistakes.

These are presented in the following figures (click on to see the figures more clearly):

WACC Calculation

WACC Calculation

Free Cash Flow (Current & Previous Periods) Calculation

Free Cash Flow (Current & Previous Periods) Calculation

Free Cash Flow (Projected Period) Calculation

Free Cash Flow (Projected Period) Calculation

Common Financial Modelling Mistakes

Common Financial Modelling Mistakes

In conclusion, these are the most frequent mistakes involved in DCF modelling and valuation. In practice, the valuation of the Company might not very much differ if you do not correct these errors, however it is particularly crucial to acknowledge such errors and correct them before being challenged by a potential strategic or financial investor.

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