When might the mid-year convention be inappropriate to use in a DCF?

The mid-year convention in discounted cash flow (DCF) analysis is typically appropriate when cash flows are expected to occur uniformly throughout the year. However, for companies with strong seasonal patterns in demand, this convention may not accurately reflect the timing of cash flows.

In such cases, cash flows are concentrated in specific periods rather than being evenly distributed. For instance, a retail company may generate the majority of its sales during the holiday season, which means that the cash inflow doesn't occur in a steady manner throughout the year. Using the mid-year convention could lead to an overestimation of the present value of cash flows because it assumes cash flows are received evenly, disregarding the actual seasonality of revenue.

Thus, when analyzing companies with significant seasonal peaks, it is essential to account for the actual timing of cash inflows to enhance the accuracy of the DCF model.