Series 79 practice questionmediumDCF Analysis
In a DCF, which of the following is a valid reason to apply the mid-year convention when discounting unlevered free cash flows?
- AIt increases the present value for all periods
- BIt adjusts for inflation in the forecast period
- CIt aligns tax payments to year-end
- DReflects that cash flows are generated throughout the year, not solely at year-end✓ Correct answer
Explanation
Why D — Reflects that cash flows are generated throughout the year, not solely at year-end
The mid-year convention recognizes that cash flows are earned continuously, so discounting to the middle of the year is more accurate than year-end. Assuming all cash flows occur at year-end understates value, which is a common exam trap.
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