Isn't a DCF basically an academic exercise?
Been looking at the technical guide which goes into DCF a lot. But the model has so many assumptions. Asking i bankers out there isn't the DCF just an academic exercise?
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Idk if it is or not, but I know that clients pay a lot of money to I-bankers to run them.
Isn't there an incentive to be optimistic rather than accurate since banks get a % of the purchase price in fees? Obviously integrity is important but I'm being practical here.
You only get paid if a transaction occurs. If no buyer wants to transact at the number your DCF spits out, you're shit out of luck.
I guess I see your point. But how would banks get an accurate DCF valuation (assuming market based valuation methods are unavailable)? Wouldn't it be much more complex in reality? Like I've read many people on this site say that I banking is just addition/mutliplication/divison/subtraction in excel but wouldn't at least some stats stats knowledge be needed to do a scenario analysis to get an expected cash flow?
Also why do we use the same WACC for each period if the capital structure changes over time?
As others mentioned, you need to balance between rosy and realistic. But any serious buyer will run their own model, so, the purpose of the DCF at the early stages is to generate interest and get buyers to submit bids - like how the purpose of the resume is to get the interview.
Once there is interest and you are further in the process, banks will work opposing bank/mgmt/PE to negotiate the value which will be guided by DCF of both banks. Most of the time, assuming both sides are only using DCF, the price will be somewhere in the middle.
There is also a bit of psychology in this, if a buyer submits a bid, then they are "bought-in" i.e. its a sunk cost, so there will be more motivated to continue the process. Also, more motivated to big the price higer b/c its a competative environment.
No in our group when we model it we try to make the valuation as rosy as possible while keeping it as accurate as we can for a sanity check.
Its also called managing client expectations. Imagine you run bs scenarios to grt valuations of $1bn when in reality the value of the company is $600-700mm. Once 1st round bids come in the client won’t sell because its way below what they’ve been expecting and also MD/firm look like idiots for being way off the mark
Essentially, yes - but it's a reliable valuation methodology to consider in conjunction with the other methodologies.
Ultimately a buyer will pay the fair market price for a business as opposed to the intrinsic value of the business.
In my opinion, the reason technical guides have a strong focus on DCFs is because it's important to understand conceptually. DCF analyses cover many important financial concepts and is something you'll likely have to draft as part of any sell-side M&A pitch.
No, every valuation methodology is derived from the time value of money either implicitly or explicitly.
Coming from a different perspective. I work at an M&A only boutique, not classic elite or regional, but somewhere in between...Anyways, we actually rarely build extensive DCFs and our models are quite simple, because the main reason to build it, at least for us, is to try and guess how much the buyer is actually expecting.
If a buyer bids for a 15% premium and says that's their best and final, but our DCF in a downside case shows 40% premium. It is likely not the best and final, so we will go back and negotiate. Obviously this is exaggerated, but you get my point.
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