DCF DCF Sensitivity Analysis 1 — Questions and Answers
Question 1: What is the primary purpose of a sensitivity analysis in a DCF model?
- To show how changes in key assumptions affect valuation (Correct answer)
- To calculate the exact intrinsic value of a company
- To determine the cost of equity using CAPM
- To forecast free cash flow for 10 years
Correct answer: To show how changes in key assumptions affect valuation
Sensitivity analysis shows how the DCF output changes when key inputs like growth rate or discount rate are varied.
Question 2: In a two-variable sensitivity table for DCF, which two inputs are most commonly tested together?
- WACC and terminal growth rate (Correct answer)
- Revenue growth and tax rate
- CapEx and depreciation
- Net income and dividends
Correct answer: WACC and terminal growth rate
WACC and terminal growth rate are the most impactful and uncertain inputs, making them the standard pair for DCF sensitivity tables.
Question 3: A DCF model shows a base-case valuation of $50/share. A sensitivity table shows values ranging from $35 to $70. What does this wide range indicate?
- The valuation is highly sensitive to input assumptions (Correct answer)
- The company's stock is incorrectly priced
- The terminal value was calculated incorrectly
- The free cash flows are too volatile to model
Correct answer: The valuation is highly sensitive to input assumptions
A wide range in the sensitivity table indicates that small changes in assumptions produce large swings in valuation, signaling high model sensitivity.
Question 4: If you increase the WACC in a DCF model while holding all else constant, what happens to the implied share price?
- It decreases (Correct answer)
- It increases
- It stays the same
- It doubles
Correct answer: It decreases
A higher WACC increases the discount rate, reducing the present value of future cash flows and thus the implied share price.
Question 5: Which tool in Excel is most commonly used to build a two-variable DCF sensitivity table?
- Data Table (What-If Analysis) (Correct answer)
- Goal Seek
- Solver
- Pivot Table
Correct answer: Data Table (What-If Analysis)
Excel's Data Table feature under What-If Analysis allows analysts to automatically populate a grid of outputs for two varying inputs.
Question 6: In a DCF sensitivity analysis, what does a 'tornado chart' visually represent?
- The relative impact of each variable on the final valuation (Correct answer)
- The historical stock price volatility
- The probability distribution of cash flows
- The correlation between revenue and EBITDA
Correct answer: The relative impact of each variable on the final valuation
A tornado chart ranks inputs by their impact on the output, with the most influential variable displayed as the widest bar at the top.
DCF DCF Sensitivity Analysis 1
What is the primary purpose of a sensitivity analysis in a DCF model?