DCF Valuation with Cash Flow Cessation Risk

Journal of Applied Finance, Spring/Summer 2012, Volume 22, Issue 1, pp. 175-185

Posted: 29 Jul 2012

See all articles by Atanu Saha

Atanu Saha

Compass Lexecon

Burton G. Malkiel

Princeton University - Bendheim Center for Finance; National Bureau of Economic Research (NBER)

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Date Written: 2012

Abstract

The typical discounted cash flow model used to value assets openly projects cash flows for an initial set of years and then typically assumes that the cash flows will grow at a constant rate into the indefinite future. In this paper, we discuss the implications for valuation and the discount rate when one assumes that cash flows have a non-zero probability of cessation throughout the valuation period. We demonstrate that, if one allows for even a small cessation probability, then a substantially higher discount rate is required in deriving the present value of the expected stream of cash flows.

Keywords: Discounted Cash Flow (DCF) model, valuation, discount rate, probability of cessation

Suggested Citation

Saha, Atanu and Malkiel, Burton G., DCF Valuation with Cash Flow Cessation Risk (2012). Journal of Applied Finance, Spring/Summer 2012, Volume 22, Issue 1, pp. 175-185, Available at SSRN: https://ssrn.com/abstract=2119220

Atanu Saha (Contact Author)

Compass Lexecon ( email )

New York, NY
United States

Burton G. Malkiel

Princeton University - Bendheim Center for Finance ( email )

26 Prospect Avenue
Princeton, NJ 08540
United States
609-258-6445 (Phone)
609-258-0771 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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