Exposing the illusion of confidence in financial analysis

Abstract

The use of discounted cashflow (DCF) techniques to evaluate major investment proposals is now commonplace. What is less generally known is that DCF analysis becomes unreliable when used to solve several common problems including the treatment of risk, real options, synergy and intangible assets. Argues that these problems occur primarily because the DCF approach assumes that decision makers are able to make accurate estimates of incremental risks and returns; a situation seldom encountered in practice. States that managers should beware the illusion of confidence created by financial figures developed in the absence of certainty. Suggests that in these cases, financial analysis should be supplemented, even supplanted, by strategic thinking and sound managerial judgement.