Discounted Cash Flow
Aussi : DCF, Discounted Cash Flow Analysis, DCF Valuation
Discounted Cash Flow (DCF) is a valuation method that estimates an asset's value by projecting future cash flows and discounting them to present value using a required rate of return.
What It Is
Discounted Cash Flow (DCF) is a valuation technique that estimates the value of an investment based on its expected future cash flows. The core idea rests on the time value of money: a dollar received today is worth more than a dollar received in the future, because today's dollar can be invested to earn a return. DCF converts future cash flows into their present value by applying a discount rate.
Why it matters
DCF is one of the most widely used methods in corporate finance, investment analysis, and capital budgeting. Unlike market-based methods (such as comparable company multiples), DCF is grounded in the fundamentals of the asset itself: how much cash it is expected to generate. This makes it useful for:
- Valuing companies, projects, or individual assets
- Deciding whether to pursue capital investments
- Supporting mergers and acquisitions decisions
- Stress-testing assumptions through scenario analysis
How it works
The general formula sums the present value of each future cash flow:
PV = CF1 / (1+r) + CF2 / (1+r)^2 + ... + CFn / (1+r)^n
Where:
- CF is the cash flow in each period
- r is the discount rate (often the Weighted Average Cost of Capital, or WACC)
- n is the number of periods
Because businesses are assumed to operate indefinitely, analysts usually add a terminal value to capture cash flows beyond the explicit forecast horizon, commonly using a perpetuity growth model or an exit multiple.
Concrete Example
Suppose a project is expected to generate 100,000 per year for 3 years, with a discount rate of 10%.
- Year 1: 100,000 / 1.10 = 90,909
- Year 2: 100,000 / 1.21 = 82,645
- Year 3: 100,000 / 1.331 = 75,131
Total present value = 248,685. If the upfront cost of the project is 230,000, the Net Present Value (NPV) is positive (about 18,685), suggesting the project creates value.
Practical Cautions
DCF outputs are highly sensitive to inputs. Small changes in the discount rate or growth assumptions can swing the valuation dramatically. Practitioners should test ranges, document assumptions, and avoid treating a single number as precise truth.