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CS Professional · Corporate Restructuring, Valuation and Insolvency · Overview of Business Valuation

Meera Pharma Ltd is valued by a method using the discounted cash flow approach. The valuer finds that the company's cost of capital has risen because market interest rates increased, with the projected cash flows unchanged. What is the likely effect on the value?

Value falls. In discounted cash flow valuation, a higher cost of capital reduces the present value of the same projected cash flows, so the business is worth less even though the cash flows themselves have not changed.

  1. AValue rises, because the discount rate is higher
  2. BValue falls, because the present value of cash flows reducesCorrect
  3. CValue is unchanged, because cash flows are unchanged
  4. DValue rises, because the terminal growth rate increases

Explanation

In DCF, future cash flows are discounted at the cost of capital. A higher discount rate lowers the present value of the same cash flows, so the enterprise value declines. Unchanged cash flows do not mean unchanged value, since the discounting changes.

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