Which has a greater impact on a DCF, the discount rate or the sales growth rate?

When evaluating a Discounted Cash Flow (DCF) analysis, the discount rate usually plays a more significant role than the sales growth rate. This is primarily because the discount rate affects the present value of future cash flows more profoundly than changes in growth assumptions.

The discount rate reflects the perceived risk and the time value of money, translating future cash flows into their present value. A higher discount rate decreases the present value of future cash flows, meaning that the overall valuation can drop significantly. Even a small change in the discount rate can lead to large fluctuations in the DCF valuation, as it is applied to all future cash flows.

On the other hand, while the sales growth rate influences future cash flow projections, it typically has a more linear effect. Changes in sales growth will affect the incremental cash flows; however, those future cash flows are still ultimately discounted back at the chosen discount rate.

Consequently, in many analyses, the discount rate may overshadow changes in the sales growth rate concerning their impact on the overall valuation. Understanding this dynamic is crucial for making informed investment decisions based on DCF models.