Discounting cash flows back to 2015--use mid-year discounting?

chipopo's picture
Rank: Senior Monkey | banana points 69

Hey all, quick question about DCF valuation. If you're valuing a company right now (mid-2015), do you discount cash flows back to 2015, or do you account for the fact that it's the middle of the year? In other words, should you discount back to 2015.5?

Thank you all in advance!

Investment Banking Interview Course

  • 7,548 questions across 469 investment banks. Crowdsourced from over 500,000 members.
  • Technical, behavioral, networking, case videos, templates. All included.
  • Most comprehensive IB interview course in the world.

Comments (10)

Jul 13, 2015

When are you predicting "the deal" closes?

Do you want to know what the company is in theory worth tomorrow or at the end of a sellside process?

Jul 13, 2015

Right now I'm looking to see what the company is worth tomorrow, which is why I'd think to use mid-year discounting--what's the appropriate way to approach this?

"True humility is not thinking less of yourself; it is thinking of yourself less."

Jul 13, 2015

Stub-year fraction

Jul 13, 2015

You discount by the number of years in your period. It shouldn't matter when you start. If you know ahead of time that your discount period will be a fraction of a year (e.g. September 1, 2015 through February 28, 2026) then you utilize a fraction (e.g. 10.5 years).

Jul 13, 2015

Thanks guys, really appreciate the help.

"True humility is not thinking less of yourself; it is thinking of yourself less."

Learn More

7,548 questions across 469 investment banks. The WSO Investment Banking Interview Prep Course has everything you'll ever need to start your career on Wall Street. Technical, Behavioral and Networking Courses + 2 Bonus Modules. Learn more.

Jul 13, 2015

If you're valuing a company using a DCF and not using a mid-year convention, you effectively are saying that all cash flows are received at the end of the year. Also, you are understating the value of the company (assuming free cash flow is positive).

As we all know, a dollar of cash flow earned on 1/1/16 is more valuable than a dollar of cash flow earned on 12/31/16. Because we don't know exactly when every dollar is earned during the year, we use the mid-year convention (e.g. 6/30/16) instead of year-end, which effectively allows you to assume that free cash flow is generated equally throughout the year.

Jul 13, 2015

Valuation Date: 3/31/16

5-Year Projections
Period 1: 12/31/16
Period 2: 12/31/17
Period 3: 12/31/18
Period 4: 12/31/19
Period 5: 12/31/20
Period 6 (stub): 3/31/21

Should the discount period for CF1 equal 0.25?

Formula is: (12/31/16-3/31/16)/365-0.5 = 0.25

Period 1 = 0.25
2 = 1.25
3 = 2.25
4 = 3.25
5 = 4.26
6 = 4.50

And the Residual Value in Terminal Year I'm using a discount period of 5.0.

Is this correctly calculating the mid-year discount period?

Thanks!

Jul 13, 2015

This is correct assuming you're using the full year for 2016. If you're only using the remaining 9 months, it is different.

Why is period 6 4.50? Shouldn't it be the average of (end of period 5) and (end of period 6)?

Otherwise looks good

Jul 13, 2015