The company’s cash flow pattern is the most significant factor in determining if you should use the mid-year convention. If your cash flows occur evenly during the year, you should use the mid-year convention. On the other hand, if your cash flows are clumped towards the end of the year, like in the case of a retailer, it may not be necessary to use the midyear convention.
Other factors that impact your decision to use the mid-year convention include the length of the forecast period, the duration of each time period in the DCF model, and the discount rates. These factors have the most weight on your decision to use a midyear convention.
The duration of each time period in the DCF model influences your decision to use a midyear convention because the longer the time duration, the more significant impact the midyear convention will have on the value of the business. Shorter time periods, say quarterly or monthly cash flows, will be less impacted by the mid-year convention when compared to year-long time periods.
The length of the forecast period in the DCF model matters because the longer the forecast period, the larger impact the midyear convention will have on the value of the business.
The discount rates matter because the midyear convention has a more significant impact on the value of the business when the discount rate is higher. The difference in the value of the business is larger when the discount rates are higher.
Note: Please do read what is the mid-year convention if this concept is not clear to you.