All kinds of businesses can be valued using the DCF valuation. However, not all companies are ideally suited for a DCF valuation. Some companies are ideally suited for DCF valuation. While some other companies are better valued using other valuation techniques such as multiples-based valuation or options-based valuation. In this article, we discuss which types of companies are ideally suited for valuation using the DCV valuation method.
While all kinds of businesses can be valued using the DCF valuation, companies that have predictable cash flows and manage their capital structure towards a target debt to equity ratio are ideal candidates for running a DCF valuation. These companies are ideal candidates for running a DCF valuation because the ability to forecast cash flows and estimate discount rates are central to the DCF valuation method.
Typically, large companies in mature markets with a long history have more predictable cash flows. Availability of information on the industry and competitors also help with making better cash flow forecasts.
A company with a stable capital structure is also an ideal condition because the discount rate used in DCF valuation incorporates the capital structure. If the capital structure is changing, you must use different discount rates for each year or use the APV method of valuation to separately account for the tax shields.
This is good. So typically a start up will not be an ideal company for DCF valuation.