Financial Management

Résumé du document

The Financial Management Seminar required us to analyze the common errors in the DCF Model introduced by Mauboussin in his article titled, "Common Errors in DCF Model" in 2006.

The Discount Cash Flow Analysis is a model that allows investors making an analysis of the risks taken by investing in a specific project. It calculates the value of an asset from its future cash flows discounted by an appropriate rate. Mauboussin has found 8 common errors in this model, and the goal of this paper is to discuss his propositions and explain our point of view.

Extraits

[...] Some characteristics are easy to be determined but other elements are not. So Mauboussin explains us that these calculus to evaluate the shareholder value lead to make some mistakes. For example, on the one hand, the rate of the pension of employees is easy to find out but on the other hand, integrating it to the calculus as the rate of private pension rate and solidarity pension rate for each employees and the difficulty of the each position is more difficult. [...]

[...] Investors have to assess the financial weight of this analysis and the risk taken, between court and long term costs linked to it. CONCLUSION I think that Mauboussin's point of view is right because it boils down to the DCF Model using. It is not the DCF Model which is a problem but the way that are using investors to make their analysis. Indeed, there is a lack of accurate information and data to get reliable results to make their decisions. [...]

[...] For example years ago, the automobile industry was in a good situation whereas during the financial crisis it is not the case at all and consequently, the risks are much higher during the financial slump. So the time context has to be used which is not the case there actually. The calculation of equity risk premium does not care about the evolvement of these factors. However, no figures and no calculations could not reflect a perfect and clear level of the risks taken by investors. We just have to be the most accurate as possible by using the figures characteristic of each company, area, industry given and so one. [...]

[...] It calculates the value of an asset from its future cash flows discounted by an appropriate rate. Mauboussin has found in this model 8 common errors and the goal of this paper is to discuss his propositions and explain our point of view. THE 8 COMMON ERRORS IN THE DCF MODEL 1. Forecast horizon that is too short According to the point of view of Mauboussin, the first problem about the Discount Cash Flow Model is that it only takes care about short term view; in order words, not more than a couple of years. [...]

[...] Distinguishing what kind of investors we are talking is necessary. Indeed, there is an important difference between an investor at long term and a speculative investor who focuses on his objectives at a higher level at short term. The main goal of an investor is to take the less level of risks by reaching the higher profitability stage at the same time. Therefore, providing that it would be an investment at a long term basis, I am agreed with the idea of Mauboussin. [...]