The problem: A DCF can look precise yet mislead when discount rates, terminal growth or forecast assumptions are unrealistic — sensitivity testing reveals how fragile the value really is.
A discounted cash flow valuation produces a single, precise-looking number, which creates false confidence. Small changes in assumptions can swing the result dramatically.
Why It Matters
Over-reliance on a point-estimate DCF leads to poor investment and strategic decisions. Understanding its sensitivities is as important as the output itself.
Where DCFs Go Wrong
- Discount rate (WACC): a rate that is too low inflates value; too high destroys it. WACC must reflect business risk and capital structure, not a round number.
- Terminal growth: a terminal growth rate above long-term GDP is unrealistic. Even 1% too much can dominate the valuation.
- Terminal value concentration: when 70–80% of value sits in the terminal, the explicit forecast barely matters — scrutinize the perpetuity assumption.
- Unrealistic forecasts: hockey-stick revenue or margin expansion that lacks operational justification distorts the explicit period.
- Sensitivity analysis: always test value across a range of WACC and growth combinations.
Illustrative Sensitivity
At a 9% WACC and 3% terminal growth, a business may be worth ₹1,000 cr. Shift to 11% WACC and 2% growth and value can fall 30% or more.
| WACC \ Terminal growth | 2% | 3% |
|---|---|---|
| 9% | ₹880 cr | ₹1,000 cr |
| 11% | ₹690 cr | ₹760 cr |
Key Takeaway
Treat a DCF as a range, not a number — stress-test WACC, terminal growth and key forecast drivers before trusting the output.