The typical DCF valuation assumes that a mature company will survive and grow at a constant rate in perpetuity. Is this a valid assumption? No, because of corporate mortality and the risk of decelerating growth, says Gil Matthews (Sutter Securities) in an article that examines this issue. Not considering these factors may result in an overstated value if you use a constant perpetual growth assumption.
Baked into CSR? BVWire asked Matthews: “Aren’t you double counting because the factors that lead to failure are already in the company-specific risk (CSR) adjustment?” No, not if it’s handled properly, he says. “Corporate mortality (or decline) is not only a company-specific risk. It often stems from factors that are not identifiable at the time of a valuation. If one first adjusts for corporate mortality, then company-specific risk should be limited to other factors.”
Mathews also points out that the courts generally reject CSR as a factor in cost of capital, deeming it to be arbitrary—and even manipulative. Adequate data on corporate mortality do not yet exist, but, once they are compiled, they will be able to be quantified and defended in litigation, in contrast to CSR.
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