Question

1. Why do companies use a mid-year adjustment when discounting future free cash flows?

2. What do you do with “in the money” executive stock options when calculating the value of a company?

Answer 1

Answer:

We generally use the basic method of discounting the cash flow that is:

Present value of cash flow = Cash flow / (1+r)n

(Where r is discount rate and n is year/current year.)

Limitation- This method has a limitation as it discounts the future value very much because it assumes that the whole value of cash flow for a particular year, comes at the end of that particular year.

Mid year discount term is used in Discounted cash flow analysis that discounts the future cash flows to the present value. It assumes that all cash flows come in half way through the year.

Formula for mid year discounting-

PV = Cash flow / (1+r) (n-.5)