Top 9 (Unnecessary and Avoidable) Mistakes in Cash Flow Valuation
16 Pages Posted: 19 Feb 2004 Last revised: 2 Apr 2019
Date Written: March 31, 2019
In cash flow valuation (CFV), there are two main categories of mistakes: derivation of the appropriate cash flows and estimation of the cost of capital. A simple-minded view of the world would suggest that with near perfect capital markets, the presence of arbitrage would severely punish wrong valuations and eradicate such mistakes in the derivations of cash flows and estimations of the cost of capital. Nonetheless, to the dismay of academics, such mistakes continue to exist and thrive. It is not clear why such mistakes persist in practice.
In this paper we present our list of the top nine mistakes in cash flow valuation. In the age of the computer these mistakes are both unnecessary and avoidable. In the usual triumph of hope over experience, we are attempting to persuade analysts that they would benefit from paying attention to these mistakes. Ultimately, the (un)importance of the mistakes is an empirical question and depends on the considered judgment of practitioners.
Keywords: Cost of capital, WACC, valuation
JEL Classification: G12, D61, G29, G31, H43
Suggested Citation: Suggested Citation