Explain discounted cash flow analysis in merger and acquisitions

Discounted cash flow (DCF) analysis tells about the present value of an asset/company, based on the money, which it can make in future. This analysis will estimate the intrinsic value of a company.

Current and future performances of a company are taken into consideration. Both inflow and outflow cash flows are discounted to the present value and sum of all the present values of future cash flows are equal to the net present value.

Categories

The categories of discounted cash flow (DCF) are explained below −

• Internal forces − Considered as solid data, because raw information (quantitative) is used. Information includes historical performances, current operations and potential.

• External forces − Market cycle and competitors' growth are external forces. It is not easy to forecast these forces. One should estimate these forces to make an accurate model.

Advantages

The advantages of discounted cash flow (DCF) are as follows −

• Detail report.
• No comparable companies are required.
• Allows sensitivity analysis.
• Suitable for analyzing.
• IRR can be calculated.
• Future expectations.

Disadvantages

The disadvantages of discounted cash flow (DCF) are as follows −

• Error prone.
• Assumptions are too large.
• Over complexity.
• Assumptions are very sensitive.
• Competitions' valuations are not considered.
• Sometimes, a person may get over confident and this may lead to miscalculations.