What is a potential consequence of using overly optimistic assumptions in a DCF model?

Using overly optimistic assumptions in a DCF (Discounted Cash Flow) model can lead to inflating the calculated present value of future cash flows. When you assume higher growth rates, increased profit margins, or lower discount rates, you effectively project future cash flows that are not realistically achievable. This can create a misleadingly high valuation of the investment because the present value calculation depends heavily on these cash flow projections.

Consequently, investors may make decisions based on an inflated valuation, believing that the investment is worth more than it actually is. This can result in overpaying for an asset and may lead to significant financial losses if the optimistic predictions do not materialize. A sound DCF analysis requires careful and realistic assumptions to ensure the integrity of the valuation process.