If you don't trust management’s projections for a DCF model, what is NOT a recommended approach?

• A. Create your own projections
• B. Modify management's projections downward
• C. Completely ignore the projections and use historical data
• D. Show sensitivity analyses based on varying growth rates

Answer: (C)

When evaluating a company's potential future cash flows for a Discounted Cash Flow (DCF) model, trust in management’s projections is crucial. If there's a lack of trust in these projections, it is important to approach the situation methodically.

Creating your own projections allows you to adjust assumptions based on your own research and analysis, providing a tailored view that reflects a more thorough understanding of the market and the company's position within it. Modifying management's projections downward can also be a strategic choice, especially if there are significant concerns about optimism bias, as it provides a more conservative approach without wholly dismissing management's insights. Conducting sensitivity analyses based on varying growth rates adds depth to the understanding of valuation by illustrating how changes in underlying assumptions can significantly impact the output of the DCF model.

Completely ignoring management's projections and solely relying on historical data is not a recommended approach because it disregards any relevant insights that may be present in management’s outlook. While historical performance is essential for understanding trends, it may not accurately reflect the future, especially in dynamic markets or during periods of change. Thus, it is crucial to consider a combination of both historical data and credible projections to derive a well-informed valuation.

By excluding management's projections entirely, you may miss