The Effect of Economic Cyclicality on Discounted Cash Flow Values

All valuation models in some way take into account the effects of timing and pattern of investment return on value. Most of the models implicitly or explicitly have an infinite or, at least a relatively long future projection horizon. A seemingly innocuous assumption common to most models is that future cash flow growth will follow a consistent growth pattern. This article considers the impact of cyclicality on typical business valuations. The analysis demonstrates that though cyclicality can dramatically impact forecast cash flows over time, attempting to integrate its impacts into a valuation results in higher expected errors.