Assumtions in DCF Model:
- Risk Free Rate of 91 days Tbill taken as 6%
- Market Risk Premium 6%
- Beta calculated from regression model = 1.2
- Tax Rate = 30%
- Terminal Growth Rate of Industry = 6%
Problem with the Assumptions:
Risk free free
- Subject to change by monteory policy.
- We are not sure about the direction of change but we are certain basis previous montetoy policies that maximum rate change is 25bps.
- Better Assumtpion: If current risk free rate of 91 days T Bill is 7% then new rate will be in range 6.75% to 7.25%
Market Risk Premium
- Indian Markets are volatile and every industry has different risk premiums
- Statisca US Market Risk Premium publication shows that lower range of 5.3% and higher range of 5,7% prevails in the US
- Using Coefficient of Variation of we can derive India Market risk premium using USA Market risk premium
- Better Assumption: Inida Market Risk Premium = USA Market Risk Premium * Coeff of Variation
Beta:
- Which granularity of data – Daily/Weekly/Monthly stock data with the Index. Every day prices will change which will impact the regression beta
- Better Assumtption: We can take 95% confidence range from regression results rather than using a point estimate for the beta
Tax Rate:
- Companies Tax structure is complex and we cannot assume a flat rate of 30%
- Better Assumption: Tax Rate lower limit 26% and higher limit 30%
Terminal Growth Rate
- We can use industry growth rate as guide for terminal growth rate but company specific growth will be different depending on the buisness life cycle
- Better Assumption: Mean Growth Rate 7% with standard deviation of 1%