How does a higher discount rate affect a DCF valuation?

A higher discount rate in a discounted cash flow (DCF) valuation typically decreases the valuation. This occurs because the discount rate is used to account for the time value of money and the risk associated with future cash flows. When the discount rate is increased, future cash flows are discounted more heavily, reducing their present value.

In simple terms, if you expect a higher return (a higher discount rate), future cash flows will be worth less today. For instance, if the discount rate is set at a higher level due to increased risk or uncertainty, the cash flows anticipated in the future will be diminished in value when assessed in today's terms. As a result, the overall DCF valuation, which sums these discounted cash flows, will decline.

This principle aligns with financial theory that suggests higher risk should command a higher expected return, reflected in the discount rate. Hence, when the discount rate rises, the present value of expected future economic benefits declines, leading to a decreased valuation of the asset in question. This is why the correct choice highlights that a higher discount rate usually decreases the valuation in a DCF analysis.