Introduction: The Central Role and Common Problems of Projections
Projected financial information (PFI) is central to income- and market-based business valuation analyses. Methods such as the discounted cash flow (DCF) fundamentally depend on the reasonableness of projected revenues, earnings before interest, taxes, depreciation, and amortization (EBITDA) margins, capital expenditures, and working capital requirements. In practice, however, those projections can sometimes be optimistic, aggressive, or based on assumptions that embed significant execution risk; conversely, they may also be overly pessimistic. They may assume double-digit growth in mature markets, rapid margin expansion without clear operational drivers, or successful execution of unproven business models in new geographies. Conversely, projections may fail to reflect reasonable future revenue growth, margin expansion, or returns on growth-oriented capital expenditures. In these circumstances, the projections do not reflect a “base case” or neutral outlook, but rather something closer to either a best-case or low-case scenario.
Pessimistic or aggressive projections can also affect the market approach by influencing the selection and application of valuation multiples. Where the subject company’s projected growth and profitability materially exceed those of the guideline public companies or transactions used for comparison, the analyst may select an artificially high multiple or assign undue weight to comparables perceived to reflect similar upside. If that projected performance is not realistically achievable, the resulting valuation may be overstated. The opposite is true when the projections are overly pessimistic.
Best Practices
As a starting point the projections must reflect a realistic assessment of the subject company’s prospects, supported by historical performance, operational growth plans, industry and macroeconomic data, capacity constraints, competition, regulatory factors, and the company’s own track record in meeting prior forecasts.
When projections are not considered to reflect the most realistic outlook, one of the most important decisions in the valuation analysis is how to address this situation.
For projections that are deemed overly optimistic, a common but flawed response is to retain those projections and simply increase the net present value factor in the discounted cash flow analysis through a company‑specific risk premium (CSRP). This approach is often viewed as subjective, difficult to support, and inconsistent with valuation best practices and the expectations of tax authorities. A more reasonable and defensible approach is to adjust the projections downward to bring them in line with a realistic base case scenario and then apply a market‑based net present value factor without layering on a subjective CSRP.
A CSRP may be appropriate in circumstances to capture risks that are not already reflected in the base weighted average cost of capital (WACC). However, it should be limited to identifiable company-specific risks that cannot otherwise be addressed separately, such as customer concentration, supplier concentration, or limited geographic diversification relative to the comparable companies as a few examples. Optimistic projections are more appropriately addressed by revising the projections themselves, rather than by applying a CSRP.
When projections appear to be pessimistic the best option is for the analyst to incorporate upward adjustments to ensure the projections reflect the most realistic outlook. As there is no “negative” CSRP that reduces the net present value factor to offset the effect of pessimistic projections, the biggest risk is taking no action and simply utilizing the pessimistic projections, resulting in an understated value.
Considerations in Revising Projections
In practice, adjusting projections can take several forms. Revenue growth assumptions may be brought closer to industry norms, the timing of market entry may be adjusted, or anticipated market share gains may be scaled back or increased. Margin projections may be moderated to levels supported by peer benchmarks and operational plans, with improvements phased in over more realistic periods if necessary. Capital expenditure and working capital assumptions may be adjusted to reflect the investment realistically required to support the revised growth path, in line with the capital intensity observed in the industry. In addition, scenario analysis can be used to replace a single optimistic case with a set of base, downside, and upside cases, with explicit probabilities assigned where appropriate. Once projections reflect a realistic base case, the net present value factor can be established using market‑derived methods without the need for a speculative company‑specific premium.
Practical Implications and Conclusion
In summary, when projected financial information does not reflect the most likely future cash flows of the company or asset, the problem lies in the projections themselves rather than in the net present value factor. Relying on a CSRP to compensate for an unsupported forecast is inherently subjective, difficult to support with market evidence, and vulnerable to challenge by tax authorities and courts (there are court rulings that address the importance for financial projections to reflect the most realistic outlook).
In practice, investors and other market participants respond to overly optimistic forecasts by revising their expectations of cash flows, not by arbitrarily increasing their required return. Valuations should mirror this behavior. Adjusting projections to a neutral, base‑case outlook, one that is grounded in historical performance, industry benchmarks, and independent forecasts, produces results that are more consistent with real‑world decision‑making, easier to explain, and more defensible in audit and controversy settings.
Revising projections forces explicit articulation of assumptions about growth, margins, and investment requirements. Those assumptions can then be tested against data and documented contemporaneously, which is particularly important in tax contexts. By contrast, small, judgmental changes in a CSRP can move value materially without a clear evidentiary basis, inviting scrutiny and dispute.
For practitioners, the practical implications are clear:
- Start by rigorously testing management’s PFI against history, peers, and the broader economic environment.
- Projections that are overly pessimistic or overly optimistic should be revised to reflect a realistic base-case scenario, with documentation for the rationale and supporting evidence.
- Derive net present value factors from market-based methods and avoid using company-specific risk premia as a substitute for correcting aspirational forecasts.
- Consider using scenario and sensitivity analysis to address uncertainty, rather than inflating the net present value factor or keeping pessimistic projections in place.
© Copyright 2026. The views expressed herein are those of the author(s) and not necessarily the views of Ankura Consulting Group, LLC, its management, its subsidiaries, its affiliates, or its other professionals. Ankura is not a law firm and cannot provide legal advice.
