2.2.6 · 40–60 minutes · read, calculate, discuss, review
What you will learn
- Interpret a discount-rate/growth sensitivity grid.
- Distinguish a sensitivity from a coherent business scenario.
- Communicate ranges without invented probabilities.
2.2 · Valuation
Valuation
Valuation · the work you will do
- 1Define the cash flow
- 2Make assumptions explicit
- 3Estimate a range
- 4Compare with price
Before you begin
One model produces £8.39 per share. A grid using other assumptions produces £6.60–£11.36. Does that make £8.39 a precise or likely forecast?
Write your first response before continuing.
Video coming soon · about 3 minutes
DCF Sensitivities and Scenarios
Use the narration below while the recording is being made, then try the decisions in this lesson.
Read the full narration
Welcome to On Judgement. One model produces £8.39 per share. A grid using other assumptions produces £6.60–£11.36. Does that make £8.39 a precise or likely forecast? Take a first view. You can change it when you have considered the evidence.
A two-way grid can change WACC down the rows and terminal growth across columns while leaving explicit cash flows unchanged. State units and exact input increments. A higher rate usually reduces present value of the same positive flows; a higher sustainable terminal growth rate increases terminal value under the teaching formula. Near r=g, values can become extreme and economically implausible.
A downside might combine weaker volume, pressure on price, delayed collections and constrained investment. An upside needs capacity and investment to deliver its sales. Changing only revenue while leaving every linked cash-flow item untouched may be incoherent. Document the business mechanism and avoid counting the same risk both by cutting cash flows and arbitrarily raising the rate without explanation.
Grid endpoints describe chosen combinations, not a measured confidence interval. The highest output is not a target the market must reach, and the base cell is not automatically the most probable. Some assumptions may be more defensible than others. If probabilities are used, explain their basis and remember that an expected value is not a guaranteed realised outcome.
Compare price with the range and identify the assumptions required to justify it. Ask which uncertainties matter most and whether more evidence could reduce them. State a review trigger tied to an observable driver. A good recommendation can be cautious or to defer: it is assessed on reasoning and evidence, not on whether a later share price happens to rise.
Let's work through Harbour sensitivity grid · £ per share. Keep FCFF 12,14,16, debt 50, excess cash 30 and 20m shares. Grid columns are terminal growth 1%,2%,3%; rows are WACC 9%,10%,11%. Pause here and try the calculation or reasoning before continuing.
WACC 9%: £8.56 | £9.76 | £11.36. WACC 10%: £7.47 | £8.39 | £9.57. WACC 11%: £6.60 | £7.32 | £8.22. At growth 2%, raising WACC from 10% to 11% lowers value from £8.39 to £7.32, using rounded cells.
At observed price £8, some chosen cells lie below price and others above it. The grid maps assumptions, not probabilities or inevitable trading outcomes.
Now try the choices in this lesson. If your answer changes, identify the reason. Communicate ranges without invented probabilities. Use the case activities to put the idea into your own words, and return to the evidence when more than one conclusion is defensible.
A sensitivity changes specified inputs
A two-way grid can change WACC down the rows and terminal growth across columns while leaving explicit cash flows unchanged. State units and exact input increments. A higher rate usually reduces present value of the same positive flows; a higher sustainable terminal growth rate increases terminal value under the teaching formula. Near r=g, values can become extreme and economically implausible.
A scenario tells a business story
A downside might combine weaker volume, pressure on price, delayed collections and constrained investment. An upside needs capacity and investment to deliver its sales. Changing only revenue while leaving every linked cash-flow item untouched may be incoherent. Document the business mechanism and avoid counting the same risk both by cutting cash flows and arbitrarily raising the rate without explanation.
A range is not a distribution
Grid endpoints describe chosen combinations, not a measured confidence interval. The highest output is not a target the market must reach, and the base cell is not automatically the most probable. Some assumptions may be more defensible than others. If probabilities are used, explain their basis and remember that an expected value is not a guaranteed realised outcome.
Use a decision rule
Compare price with the range and identify the assumptions required to justify it. Ask which uncertainties matter most and whether more evidence could reduce them. State a review trigger tied to an observable driver. A good recommendation can be cautious or to defer: it is assessed on reasoning and evidence, not on whether a later share price happens to rise.
Harbour sensitivity grid · £ per share
Sensitivity to the required return
What happens to value as the required return rises, and why?
Keep FCFF 12,14,16, debt 50, excess cash 30 and 20m shares. Grid columns are terminal growth 1%,2%,3%; rows are WACC 9%,10%,11%.
- WACC 9%: £8.56 | £9.76 | £11.36.
- WACC 10%: £7.47 | £8.39 | £9.57.
- WACC 11%: £6.60 | £7.32 | £8.22.
- At growth 2%, raising WACC from 10% to 11% lowers value from £8.39 to £7.32, using rounded cells.
At observed price £8, some chosen cells lie below price and others above it. The grid maps assumptions, not probabilities or inevitable trading outcomes.
| WACC / terminal growth | 1% | 2% | 3% |
|---|---|---|---|
| 9% | £8.56 | £9.76 | £11.36 |
| 10% | £7.47 | £8.39 | £9.57 |
| 11% | £6.60 | £7.32 | £8.22 |
Put it into practice
1. Read the grid
Find the value at 11% WACC / 3% growth, then compare 9% / 1%.
Record your response in your workbook before opening feedback.
Compare with a model response
The values are £8.22 and £8.56 respectively. A growth increase can partly offset a higher discount rate; labels and interaction matter.
2. Build a coherent downside
Describe three connected changes to Harbour’s cash-flow forecast if a major customer delays orders.
Record your response in your workbook before opening feedback.
Compare with a model response
Lower volume reduces revenue; inventory may accumulate and collections may slow; capex might be postponed, but that can also constrain recovery. Quantify links before treating the scenario as internally consistent.
3. Write the caveat
Explain in 100 words why the grid’s £6.60–£11.36 range should not be called a 95% interval.
Record your response in your workbook before opening feedback.
Compare with a model response
The endpoints come from selected parameter combinations with no fitted probability model. Other operating outcomes, rates and growth paths may lie outside. Explain which inputs are plausible and what evidence could support them.
Jargon buster
Sensitivity grid
Outputs calculated for labelled combinations of selected inputs.
Base case
A reference assumption set, not a known future.
Downside
An adverse scenario defined by a coherent economic mechanism.
Upside
A favourable scenario with supporting assumptions and resource needs.
Confidence interval
A statistical interval requiring an appropriate probabilistic basis.
Review trigger
Evidence that would lead to reconsidering a decision or assumption.
Knowledge check
Make each choice on the page. Feedback explains the reasoning. Use Try again after revisiting an idea.
AQA connection and further reading
AQA 7138 connections: 3.1.4 financial management, 3.3.3 strategy/investment appraisal, 3.3.4 change and uncertainty; Annex 6 quantitative interpretation; AO2–AO4 application, analysis and evaluation. Enterprise DCF, WACC, trading multiples and SOTP are investing enrichment, not prescribed AQA company-valuation methods.
AQA 7138 specification
Primary curriculum mapping; teacher interpretation, not endorsement.
IAS 7 overview · IFRS Foundation
Accounting classification context. Presentation changes and effective/adoption dates must be checked for real reports.
Free Cash Flow Valuation · CFA Institute
Technical cross-check for consistent claims and valuation formulas; advanced optional reading.
Introduction to Valuation · Aswath Damodaran, NYU
Optional deeper reading on valuation approaches.
Take forward
Interpret a discount-rate/growth sensitivity grid. Distinguish a sensitivity from a coherent business scenario. Communicate ranges without invented probabilities.