DCF investment horizon


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Posted by Bob on April 06, 19101 at 12:09:06:

As elaborated at the Global Value Investing and DCF Valuator websites, the investment horizon is independent of the risk-free rate and of the investor's opportunity cost.

The investor-specific investment horizon is the length of time until the investor plans on liquidating his or her investment by selling it for retirement, college tuition, or other consumption.

Tne investor-specific opportunity cost is the next highest rate of return that he or she could earn on the same amount of invested capital. Often, this is a so-called risk-free rate on U.S. government securities of a term comparable to the investment horizon.

Thus, the logical order is to determine the investment horizon first, and then find the current yield on a U.S. bond or note nearest in term to maturity.

The "correlation" between 5% and 20 years, or between 7% and 14 years, appears to be nothing more than the result of capitalizing a cash flow stream -- assuming a constant growth rate in *perpetuity* or an infinite number of years. Thus, 1/0.05 = 20 times, and 1/0.07 = 14 times. Conversely, a multiple of 10 times is equivalent to a discount factor of 10% (1/0.10 = 10%). This is a highly simplistic model of discounting the expected growth, and can lead to strange results, as discussed at the website, in the investment model Help windows, and in past articles of the Insighter newsletter.



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