Valuation Techniques: Discounted Cash Flow, Earnings Quality, Measures of Value Added, and Real Options

QUESTION AND ANSWER SECTION

Question: What range of discount rates should be used in a DCF analysis?

Gilbert: The answer depends on the company. When you are dealing with start-up companies, you look to rates expected by venture capitalists—perhaps rates as high as 100 percent per year, or even more. The fact that these are very high rates implies—among other things—that you do not have a lot of faith in the cash-flow stream being discounted. For companies that are not start-ups, the rate normally falls in the 10- to 30-percent range.

Question: Should the discount rate be pre-tax or post-tax?

Gilbert: The answer depends on whether the cash flows are net of taxes. Most appraisers use free cash-flow and post-tax discount rates.

Question: Is it appropriate to use a higher discount rate for the terminal value to account for a higher risk so far into the future?

Gilbert: It makes a lot of sense conceptually to use a higher discount rate, but you almost never see it done.

Question: Is the value derived in the DCF analysis a minority-interest value or a controlling-interest value?

Gilbert: The value depends on whether you use a control discount rate or a minority-interest discount rate. For example, if you adjust for owner’s compensation and add back a huge increment because the owner is taking excessive compensation, then you have probably captured a good portion of the control premium in the cash-flow stream (numerator). Similarly, if you are valuing a minority interest and you do not ...