DISCOUNTED

CASHFLOW
VALUATION
TECHNIQUE
 DISCOUNTED CASHFLOW
VALUATION
▸ Refers to a valuation method that estimates the value of an investment using its
expected future cash flows.
▸ DCF analysis attempts to determine the value of an investment today, based on
projections of how much money that investment will generate in the future.
▸ It can help those considering whether to acquire a company or buy securities
make their decisions.
▸ It can also assist business owners and managers in making capital budgeting or
operating expenditures decisions.

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 How does discounted cash flow
▸ work?
The purpose of DCF analysis is to estimate the money an investor
would receive from an investment, adjusted for the time value of
money.
▸ A DCF analysis is useful in any situation where a person is paying
money in the present with expectations of receiving more money in the
future.
▸ Discounted cash flow analysis finds the present value of expected
future cash flows using a discount rate. Investors can use the concept
of the present value of money to determine whether the future cash
flows of an investment or project are greater than the value of the 3
 How does discounted cash flow
thework?
▸ If the DCF value calculated is higher than the current cost of the investment,
opportunity should be considered.
▸ If the calculated value is lower than the cost, then it may not be a good
opportunity, or more research and analysis may be needed before moving
forward with it.
▸ To conduct a DCF analysis, an investor must make estimates about future cash
flows and the ending value of the investment, equipment, or other assets.
▸ The investor must also determine an appropriate discount rate for the DCF
model, which will vary depending on the project or investment under
consideration. If the investor cannot estimate future cash flows, or the project is
very complex, DCF will not have much value and alternative models should be
employed. 4
 Advantage and disadvantage of
discounted flow
▸ Discounted cash flow analysis can provide ▸ The major limitation of discounted cash flow
investors and companies with an idea of analysis is that it involves estimates, not actual
whether a proposed investment is worthwhile. figures. The result of DCF is also an estimate. That
▸ It is an analysis that can be applied to a means that for DCF to be useful, individual
variety of investments and capital projects investors and companies must estimate a discount
rate and cash flows correctly.
where future cash flows can be reasonably
▸ DCF shouldn't necessarily be relied on exclusively
estimated.
even if solid estimates can be made. Companies and
▸ Its projections can be tweaked to provide
investors should consider other, known factors as
different results for various what-if scenarios.
well when sizing up an investment opportunity. In
This can help users account for different addition, comparable company analysis and
projections that might be possible. precedent transactions are two other, common
valuation methods that might be used.

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 Formula for discounted
cashflow

Where:

CF1=The cash flow for year one

CF 2= The cash flow for year two

CF n= The cash flow for additional years

r=The discount rate

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Example:
A company has a current investment value of $24,500, free cash
flow of $450,000, future projected investment returns of $925,000
and a discount rate of 15%.
It can use this information to perform DCF analysis over three
years by working through the formula:

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SOLUTI
ON:
$ 450 , 000 $ 450 , 000 $ 450 , 000
𝐷𝐶𝐹 = 1
+ 2
+
( 1+ 0 . 15 ) ( 1+ 0 . 15 ) ( 1 + 0 . 15 ) 3

DCF= 391,304.35+304,909.09+296,052.63
DCF= $992,266.06
It shows the company can expect the investment to provide them with a return
that appears well above its initial projection of $925,000. Because of the high
valuation of the future expected cash flow, the company may decide to move
forward with its investment.
 Difference between discounted cash
flow and net present value
Discounted Cash Flow is a financial model and can be viewed as the primary tool in valuation that is
used to estimate the intrinsic value of any asset that generates cash flows.
The key proposition within the DCF is that the value of an asset is the present value of its future cash
flows:

The end goal is to determine the value of an investment which then can be used to decide whether the
investment or project should be made or not.
The two primary components within a DCF are the cash flows and the discount rate.
Which in valuation is (1) to forecast cash flows
And to come up with a respective discount rate (2).
Analysts and advanced investors usually spend a lot of time and effort on both components of the DCF
because they require making reasonable assessments of a company’s risk profile and often vague
estimates about its future. 9
 Difference between discounted cash
flow and net present value
The net present value (NPV) is the present value of all future cash flows within the DCF adjusted by
the initial investment that had to be made in the first place.
NPV is the difference between the initial investment costs and the present value of the asset:

By computing the NPV can either be positive or negative.

The initial investment costs to fund a given project/investment can either be lower or higher than its
present value. Any NPV that is positive (>0) shows that there is excess value that can be made from
the investment/project.
That’s why companies often use the NPV metric to determine whether a project is worth the
investment or not.

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The Discounted Cash Flow is the general approach of estimating
the value of any investment based on its remaining lifespan, the
magnitude of cash flows it produces, and the risk around generating
those cash flows. NPV, on the other hand, is a metric that can be
computed in order to quickly determine whether a given project is
worth the investment or not.

The process of discounting cash flows and calculating the net

present value can come in very handy in many financial decisions
which is why it is commonly used in corporate decisions, financial
analysis, and investment valuations. 11