Equity valuation using DCF: a theoretical analysis of the long term hypotheses

This paper matches the sensitivity analysis of two-stage DCF models to the assumption of Long Term Steady-State. It proposes the definition of ‘Joint Sensitivity’ that measures the effect on the firm’s value of joint variations of more input parameters. The duration of the first stage of explicit forecast is one of the most important of these parameters. The assumptions leading to the definition of such length is that the company exhausts in that year its competitive advantage over the competitors and begins a period of Steady-State. So, the end of the Competitive Advantage Period, defined as the period during which the return on capital can be higher than its cost, coincides with the end of the first stage of explicit forecast of the DCF. This paper proposes an instrument (Excess Return) that measures the theoretical reliability of a valuation by verifying if the return on invested capital is asymptotically equal to its average cost.