Which has greater impact on a company's DCF valuation - a 10% change in revenue or a 1% change in the discount rate?

Which has greater impact on a company's DCF valuation - a 10% change in revenue or a 1% change in the discount rate?

• A. 10% change in revenue
• B. 1% change in discount rate
• C. They have equal impact
• D. It depends on growth rate

Answer: (A)

The key idea is that DCF value is driven by the actual levels of future cash flows, not just how you discount them. A 10% change in revenue directly lifts (or reduces) the cash flows you expect in every future year by roughly that amount, and because those cash flows are received over many years and fed into the terminal value, the effect compounds and translates into a large change in present value. In contrast, a 1 percentage-point change in the discount rate adjusts how much each of those same cash flows is worth today, but the overall impact on the total present value is smaller—it depends on the duration of the cash-flow stream, and even with long durations the relative effect is typically less than a proportional shift in cash flows. So a sizable change in revenue tends to move the DCF valuation more than a small shift in the discount rate.

The key idea is that DCF value is driven by the actual levels of future cash flows, not just how you discount them. A 10% change in revenue directly lifts (or reduces) the cash flows you expect in every future year by roughly that amount, and because those cash flows are received over many years and fed into the terminal value, the effect compounds and translates into a large change in present value. In contrast, a 1 percentage-point change in the discount rate adjusts how much each of those same cash flows is worth today, but the overall impact on the total present value is smaller—it depends on the duration of the cash-flow stream, and even with long durations the relative effect is typically less than a proportional shift in cash flows. So a sizable change in revenue tends to move the DCF valuation more than a small shift in the discount rate.