Topic 61
Free Cash Flow Equivalent Impacts for Arbitrary Adjustments to Discount Rates
Topic 61 provides insight into the negotiation process drawbacks and valuation impacts of making arbitrary “risk” adjustments to discount rates.
The reader is encouraged to take the time to read the text in conjunction with the referenced Appendices to gain the appropriate level of understanding of the subject matter discussed in the narrative. Appendices are either presented at the end of this and each remaining Topic or are available for review and download on this book's companion Web site (see the About the Web Site page for login information).
ARBITRARY ADJUSTMENTS DISCUSSION
- Although not the preferred or most informative method to compensate for unsystematic risk when valuing a business, arbitrary adjustments to discount rates are often made in an attempt to “adjust” for certain perceived unsystematic risks inherent in the free cash flow (FCF) rather than quantifying the risks and making the adjustments directly to the FCF element.
- In some cases, the FCF forecast is judged to be overstated or to have such volatility that the discount rate is adjusted in an attempt to dampen the volatility or to correct the forecast overstatement, thereby resulting in a value that has a higher confidence level of realization (as if it resulted from a lower-level FCF forecast with less volatility risk and an unadjusted discount rate).
- In other cases, investors simply want a higher return. Therefore, they ...
