A ten-year DCF whose reversion accounts for 60% of total present value indicates:
Correct Answer
B) The terminal rate assumption dominates the conclusion
Why this is correct: In a Discounted Cash Flow (DCF) analysis, if the present value of the reversion (terminal value) constitutes a large portion (like 60%) of the total present value, the valuation conclusion is highly sensitive to the assumptions used to calculate that reversion, particularly the terminal capitalization rate. Why the other choices are wrong: "The projection period was chosen correctly for the asset" cannot be concluded from the reversion's weight alone. "Operating income is unusually strong" would typically increase the weight of the interim cash flows, not the reversion. "The discount rate has minimal influence" is false; both the discount rate and terminal rate significantly influence the result. Exam tip: When the reversion dominates value, small changes in the exit cap rate create large value swings. Support your terminal cap rate with strong market evidence.
Why This Is the Correct Answer
Why this is correct: In a Discounted Cash Flow (DCF) analysis, if the present value of the reversion (terminal value) constitutes a large portion (like 60%) of the total present value, the valuation conclusion is highly sensitive to the assumptions used to calculate that reversion, particularly the terminal capitalization rate. Why the other choices are wrong: "The projection period was chosen correctly for the asset" cannot be concluded from the reversion's weight alone. "Operating income is unusually strong" would typically increase the weight of the interim cash flows, not the reversion. "The discount rate has minimal influence" is false; both the discount rate and terminal rate significantly influence the result. Exam tip: When the reversion dominates value, small changes in the exit cap rate create large value swings. Support your terminal cap rate with strong market evidence.
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