Why is a DCF not a good measure of value on its own?

• A. Because changing assumptions can dramatically affect valuation
• B. Because it ignores debt
• C. Because it only considers market comps
• D. Because it always overvalues

Answer: (A)

A DCF value is driven entirely by the inputs you put in—projected free cash flows, the discount rate, and the terminal value—so small changes in those assumptions can swing the valuation a lot. Future cash flows are inherently uncertain, and the discount rate (which reflects risk and the cost of capital) and the method for estimating terminal value often dominate the result. Because the terminal value can make up a large share of the total, tweaks to growth rates, margins, investment needs, or the capital structure can dramatically alter the present value. This is why a DCF is best used as one piece of analysis, supplemented with sensitivity or scenario analysis and triangulated with other valuation methods.

Debt can be incorporated depending on the variant you use (value the firm using cash flows to the firm and a firm discount rate, or value equity with cash flows to equity and a equity discount rate), so it isn’t inherently ignoring debt. DCF doesn’t rely on market comps by design, which is why it isn’t a measure of value based on market multiples alone. And no, a DCF does not always overvalue; its outcome can rise or fall with the assumptions.