DCF is Simple and Practical. Real Options are Too Complex
Nick Moore, Financial Consultant, United Kingdom
It is true that DCF on its own does not adequately show risk. But there are a number of methods that can be utilised in a DCF calculation to show risk:
1. Use an appropriate discount rate
for the risk.
2. Use sensitivities
3. Use Monte Carlo Analysis
, although this is starting to get almost as complex as the valuation of real options
, so is not practical for most business use.
At the end of the day, the DCF analysis gives one data point, and judgement should always be used, combined with other metrics (such as IRR
) to determine if a project is good or bad.