Question 11.S-tQ.6: Explain why the DCF valuation method is preferred by academi...

The DCF valuation method is preferred by academics because it is directly related to the ideal of shareholder wealth maximisation. Practical difficulties with this method include:

• estimating future cash flows;
• the choice of an appropriate discount rate;
• the selection of an appropriate time period over which to evaluate;
• how to forecast accurately any economies of scale and synergies;
• taking account of the risk of the target company;
• estimating the future cost of capital.

The appropriate discount rate with which to discount expected cash flows could be the acquiring company’s cost of capital or a discount rate reflecting the systematic risk of the target company.