Discounted Cash Flow
(DCF)

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Discounted Cash Flow (DCF) is, what amount someone is willing to pay today, in order to receive the anticipated cash flow of future years. The DCF method converts future earnings to today's money. The future cash flows must be recalculated (discounted) to represent their present values. In this way the value of a company or project under consideration as a whole is determined properly.

Discounted Cash Flow calculation

The DCF for an investment is calculated by estimating: the cash that you will have to pay out, and the cash which you expect to receive back. The timeframes that you expect to receive the payments must also be estimated. Each cash transaction must then be recalculated, by subtracting the opportunity cost of capital between now and the moment when you will pay or receive the cash.

DCF example

For example, if inflation is 6%, the value of your money would halve every ±12 years. If you expect that a particular asset will provide you an income of $30.000 in 12 years from now, that income stream would be worth $15.000 today if inflation was 6% for the period. We have now discounted the cash flow of $30.000: it is only worth $15.000 for you at this moment.
 

Why Discounted Cash Flow?

The DCF method is an approach for valuation, whereby projected future cashflows are discounted at an interest rate (also called: Rate of Return), that reflects the perceived amount of risk of the cash flows. In fact, the discount rate reflects two things:

1. The time value of money. Any investor would prefer to have cash immediately than having to wait. Therefore investors must be compensated by paying for the delay.
2. A risk premium that represents the extra return which investors demand, because they want compensation for the risk that the cash flow might not materialize.

History of DCF

Discounted Cash Flow was first formally articulated in 1938 in a text by John Burr Williams: 'The Theory of Investment Value'. This was after the market crash of 1929 and before auditing and public accounting were mandated by the SEC. Understandably, as a result of the crash, investors were wary of relying on reported earnings, or in fact any measures of value apart from cash. Throughout the 1980s and 1990s, the value of cash and physical assets gradually became less well correlated with the total value of the company (as determined by the stock market). According to some estimates, tangible assets dropped towards less than one-fifth of the total corporate value. Intangible assets, such as customer relationships, patents, proprietary business models, channels, etc., are the remaining four-fifths.

Book: S. David Young, Stephen F. O'Byrne - EVA and Value-Based Management: A Practical Guide..

Book: Aswath Damodaran - Investment Valuation: Tools and Techniques for Determining Value..

Book: James R. Hitchner - Financial Valuation: Applications and Models

Forum Forum discussions about Discounted Cash Flow. Below you can ask a question about this topic, share your experiences, report a new development, or explain something. Start a new topic about Discounted Cash Flow Share your knowledge here (or ask a question)   DCF vs Present Value Can someone please explain the difference between the Discounted Cash Flow (DCF) and Present Value (PV)?... 7   1 comments DCF Method versus CAPM Model What are the differences between discounted cash flow methods and capital asset pricing model?... 5   2 comments 🔥 NEW What is Discounted Cash Flow? (DCF) DCF shows the future cash inflows at a discounted rate. In simple terms, DCF tells us about how much our future inflows are worth at the present. Background: the money that we have today wil... 4   Advising Finance and Small Business If you are a financial advisor to small businesses, please don't try to use investment theory when explaining how they should manage business cash flow. You will end up with zero result. But this is w... 3   1 comments DCF Simple but has Weaknesses! The DCF method is the simplest in use, but is a complete failure in measuring uncertainty and risk, so simulation and the real options method hold the key for those situations...... 1   2 comments DCF for Capital Projects in Condo Association QUESTION: Hi, Condo association is planning roof replacement ten years from now. Today estimations are $1M. Should discounting be applied to this project? It means that future cost of the project... -3   2 comments

Information Sources Various sources of information regarding Discounted Cash Flow. Here you will find powerpoints, videos, news, etc. to use in your own lectures and workshops. Residual Income, EVA and DCF Valuation In this teaching note using a complex example with varying debt, varying leverage and terminal (or continuing value), we... Business Valuation | Company Valuation | Firm Valuation Business Analysis, Company Analysis | Firm Analysis This presentation elaborates on the valuation and analysis of companies and include the following sections: 1. Company ... Corporate Valuation for Businesses Corporate Valuation, Book Value, Market Value, Intrinsic Value, Fundamental Value, M&A, VBM, Fundamental Investing Presentation that elaborates on corporate valuation, including the following sections: 1. Three types of value: - Book... Introduction to Discounted Cash Flow Initial Understanding of DCF Introduction to Discounted Cash Flow, a valuation method, used to estimated the attractiveness of an investment opportun... How to Calculate NPV in MS Excel Basic Understanding of how to use Excel for calculating NPV The Net Present Value of an investment is the present value of the investment minus the amount of money it cost to buy i...

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Compare with Discounted Cash Flow: Net Present Value  |  Payback Period  |  IRR  |  Management Buy-out  |  Economic Margin  |  Relative Value of Growth  |  Total Cost of Ownership  |  CAGR  |  Cost of Equity

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