Mid-Year Convention

Under year-end convention, Year 1 cash flow is discounted by (1+r)^1. Under mid-year convention, it's discounted by (1+r)^0.5. Since the exponent is smaller, the present value is higher. The effect is equivalent to multiplying the entire year-end DCF by (1+r)^0.5 — typically a 3–5% uplift in valuation. The mid-year convention is the standard in investment banking DCF models.

Use mid-year convention for companies with relatively stable, evenly distributed cash flows throughout the year (most businesses). Use year-end convention for businesses with heavily back-loaded cash flows (some retailers with Q4 concentration). For stub periods (partial years), adjust the discount period accordingly — e.g., if you're valuing mid-year, the first period might be 0.25 instead of 0.5.

The mid-year convention also applies to the terminal value. If using the exit multiple method, the terminal value is discounted from the midpoint of the final projected year. If using the Gordon Growth method, the terminal value is calculated at the end of the last projected year and then discounted using mid-year adjustments. Getting this right matters because terminal value often represents 60–80% of total DCF value.