I have already written about discounted cash flow method of valuation now let’s look at some of the advantages and disadvantages of DCF method
Advantages of discounted cash flow method –
1. It can be applied for valuing business as a whole and also for valuing individual business components of a company or firm.
2. It is simple to understand and apply and also if needed it can be modified to deal with complex circumstances also.
3. It can be used by both equity shareholders because on the basis of DCF valuation they can compare two companies and take decision whether to invest or not, and also debt holders can use DCF method to take decision regarding the company.
Disadvantages of discounted cash flow method
1. Since it is a valuation tool it is dependent heavily on the inputs used for valuation purpose, so if inputs are changed slightly there can be large change in the value of a company.
2. Also since it makes use of future cash flows as an input, which we all know, are difficult to predict for any company and hence the success of DCF method is directly related to whether one can predict the future cash flows accurately or not.
Therefore anybody who is using discounted cash flow method should also use other methods of valuation along with in order to take right decision regarding the investment in the company.