Reading: Introduction

We have seen that continuing value is often a significant fraction of estimated firm value. Since the methods used to gauge continuing value are fairly speculative, many critics question the use of the DCF method of firm valuation. Why bother with an elaborate estimation of the PV of the forecast period, when one has to rely on guesswork to compute continuing value anyway?

The answer we can give is twofold. First, all firm valuation methods explicitly or implicitly face the problem of having to forecast the firm's fortunes several years ahead. This problem is not unique to the DCF method. Think of what the stock market does when computing stock prices every day. The present value of the next 5 dividend payments represents a fraction of only about 10-30% of stock prices in many countries across the world. That means, the market must be thinking about future dividends in the far future, no matter what valuation method it uses.

Second, there is nothing wrong with the DCF method, quite the contrary. It's just that its implementation in the case of firm valuation confronts the analyst with the thorny problem of gauging continuing value. But this is no reason to give up on the method. If nothing else, it helps the analyst think about the determinants of firm value in a coherent way.