What is the optimal time frame to forecast for a DCF and why?
Answer
Typically, you’ll look to forecast 5-8 years depending on the sophistication of the business. Anything less than this is too short to be useful and anything longer is too far out to be reliable.
Why this matters to bankers
Bankers must defend their DCFs to their superiors and clients. It’s important to forecast a reasonable period of time to create a reasonable DCF. Think about how much of the total valuation is composed of terminal value (usually 2/3). The more years you forecast, the larger the business gets than it is today, and the less trustworthy the final year anchor that drives terminal value is.