Discounted cash flow: accounting for uncertainty

Purpose – Valuation is the process of estimating price. The methods used to determine value attempt to model the thought processes of the market and thus estimate price by reference to observed historic data. This information is utilised in the discounted cash flow (DCF) valuation model to determine the single point valuation figure. However, the valuation will be affected by uncertainties: uncertainty in the comparable data available; uncertainty in the current and future market conditions and uncertainty in the specific inputs for the subject property. These input uncertainties will translate into an uncertainty with the output figure, the estimate of price. This paper discusses ways in which uncertainty can be incorporated into the DCF model.Design/methodology/approach – This paper looks at the way in which uncertainty can be incorporated into the explicit DCF model. This is done by recognising that the input variables are uncertain and will have a probability distribution pertaining to each of them. T...