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Key Assumptions & Inputs

Concept

Valuation is only as reliable as the assumptions built into your analysis. Small changes in growth rates, discount rates, or cost structures can lead to large swings in the final valuation. The process of making—and rigorously testing—these assumptions is central to producing credible, defensible valuations.

Core Assumptions in Valuation​

  1. Growth Rates

    • Revenue Growth: Affects top-line projections and often sets the tone for downstream profitability.
    • Terminal Growth: Small percentage changes in terminal value assumptions can significantly alter the final valuation.
    • Operating Income or EBITDA Growth: Reflects expectations around efficiency, pricing, and competitive positioning.

  2. Discount Rates

    • WACC: For DCF analyses of enterprise value, ensure each input—cost of equity, cost of debt, and capital structure weights—reflects current market conditions.
    • Cost of Equity: In equity valuation scenarios, CAPM or alternative models can be used, with risk-free rates, beta, and market risk premiums driving significant variations in the outcome.

  3. Tax Rates

    • Impacts everything from NOPAT to the after-tax cost of debt.
    • Consider effective tax rates if the statutory rate doesn’t reflect actual taxes paid (due to credits, losses, etc.).

  4. Capital Expenditures (CapEx) & Depreciation

    • CapEx: Key driver of future Free Cash Flow (FCF) since it directly reduces operating cash flows.
    • Depreciation & Amortization: Non-cash expenses, but they affect reported earnings and tax liabilities. Must be aligned with CapEx assumptions.

  5. Working Capital Requirements

    • Changes in receivables, payables, and inventory can impact short-term liquidity and FCF.
    • Rapidly growing companies may need higher working capital, reducing free cash flow in the near term.

Macroeconomic Factors​

  1. Interest Rates

    • Affect the discount rate (WACC, cost of debt) and the overall market environment.
    • Higher rates generally lower valuations by increasing the discount rate.

  2. Inflation

    • Can erode purchasing power and alter cost structures.
    • Influences nominal discount rates and nominal revenue/margin projections. See Inflation for more details.

  3. Currency Risks

    • For businesses with international operations, exchange rates impact revenue, costs, and thus valuations.
    • Consider hedging strategies or local market multiples for valuation comparables.

  4. Economic Growth & Sector Cycles

    • Broader GDP growth or recessionary conditions can raise or lower demand for a company’s products/services, thus affecting both near-term and long-term forecasts.
Takeaway

Crafting a valuation hinges on getting the assumptions right—or at least making them transparent and subjecting them to sensitivity and scenario analyses. Keeping track of macroeconomic factors and aligning your model inputs with realistic, well-researched expectations will lend greater credibility and robustness to your valuation conclusions.