Here is a view on DCF valuation from Heiko Ziehms, a forensic accountant and an M&A disputes expert in London and author of M&A Disputes: How They Happen, How to Resolve Them, How to Avoid Them (Wolters Kluwer, 2023). The valuation chapter in that book covers both DCF valuation and Residual Earning valuation.
My perspective may be more European than US-based, but I’d observe that the DCF method is very common, and even used by many PE buyers who primarily value the business on a multiple basis (usually EBITDA) but then often cross-check that valuation using a DCF (or there is a fairness opinion in relation to the proposed transaction that involves a DCF valuation). I also observe that many large corporates, at least in Europe, require a DCF valuation as part of their board-approved acquisition procedures. Some even prescribe a specific discount rate, an approach that would not appear consistent with the idea that the cost of capital should reflect the systematic risk of the acquisition target. Many derive the cost of equity in the WACC on the basis of the CAPM, basically always the single factor version of Fama. But I think it may be the exception rather than the rule that the resulting discount rate is a genuine, independent best estimate of the cost of capital of the target firm that, in turn, really drives the valuation outcome.
My perspective may also be tainted by the subset of deals that go wrong and end up in disputes as those are the ones I get to see primarily nowadays. Once it’s clear how “soft” the cost of capital figure is, and how sensitive the valuation to it, it’s often treated as a plug (along with the terminal value growth rate that has similar properties). In these cases, the discount rate essentially serves to get to the valuation outcome that is desired for whatever other reason. For example, a dynamic that I’ve seen is that a corporate will look at an acquisition target and obtain board or senior management approval “in principle” within what is considered by the board to be an acceptable valuation range. During the due diligence, all kinds of things turn up that are relevant to ‘value’, some significant. But then a kind of ‘commitment bias’ kicks in to retain the original valuation range, especially when board-approved, and a wish to rationalise away adverse due diligence findings. If given the freedom, the deal team will then then fiddle around with the market risk premium, the peer group (and, by extension, the beta factor), the terminal value growth rate, or some other input variable in the DCF model, in effect to neutralise the impact on value of the findings that the due diligence turned up (and that are otherwise unrelated to the cost of capital). So approvals may often simply come too early. This dynamic combines with institutional inertia and perhaps a deeply held belief by senior leadership of what value ‘really’ is, or should be, quite apart from the output of the valuation model, that is that the ‘true’ value is driven by other (bigger) things.