What is the relationship between revenue increases and costs in a DCF valuation?

In a Discounted Cash Flow (DCF) valuation, increased revenue generally leads to a proportional increase in costs. This relationship reflects the reality that as a company grows its sales and services, it often incurs additional expenses to support that growth. These costs may include variable expenses directly tied to production levels, such as raw materials and labor, as well as fixed costs that can also scale with growth, like operational and administrative expenses.

Understanding this relationship is crucial for accurately forecasting cash flows, as it affects profitability. If revenue increases significantly, while costs may not increase at the same rate due to economies of scale, they typically still rise proportionately to support that revenue generation, especially in established businesses without substantial fixed-cost leverage. Consequently, modeling this relationship helps in evaluating the future cash flows of a business, which is the cornerstone of DCF analysis.

The other options suggest alternative scenarios that do not typically reflect the dynamics of most businesses. For instance, the idea that increased revenue decreases total costs or keeps them static is contrary to common operational realities.