In our Lunch DIScussions on "The Limits of the Discounted Cash Flow Approach: The Good, the Bad, and the Ugly," the experts Alexander Demuth, Björn Brand, and Christian Gruschwitz from Secretariat discussed the multifaceted nature of the Discounted Cash Flow (DCF) method, highlighting its role in both valuation and damages assessment within arbitration and litigation settings.
The discussion delineated the fundamental elements of the DCF method, including the identification and projection of cash flows, the determination of an appropriate discount rate, and the calculation of both present and terminal values. It highlighted the method's inherent reliance on estimates rather than actuals, emphasizing the importance of precision in estimating future cash flows and discount rates.
The discussion explored the rationale behind the reliance on the DCF approach, attributing it to its inherent flexibility which allows for a comprehensive consideration of various effects and circumstances. Addressing the application of the DCF method in damages determination, the discussion outlined two primary approaches: the direct approach, focusing on the immediate financial impact of harmful events, and the indirect (but-for) approach, comparing hypothetical scenarios absent the wrongful act with actual outcomes. Each approach was critically analyzed, with attention to the challenges of data availability, the relevance of historical financial data, and the complexities involved in adjusting cash flows for unrelated external factors.
The key components of a DCF analysis were examined, including the selection of valuation dates, the definition of the damages period, the establishment of cash flows, the determination of the discount rate, and the calculation of terminal value. Each element was dissected to reveal its potential to significantly influence the outcome of a valuation or damage assessment, emphasizing the nuanced considerations that must be accounted for to avoid misrepresentation or manipulation of financial outcomes.
Further, the discussion considered some real-life case examples; the questions raised by the audience resulted in a lively LunchDIScussion.
Christian Gruschwitz