Discount Cash Flow (DCF) is to calculating method to estimate the effect or return of investment. In DCF method, cash flow is calculated as Net Present Value (NPV).
Concept of DCF
If you have 100K USD, what is value a year later? Answer depends on interest rate. If interest rate is 3%, value of 100K USD is 103K USD a year later. It means that present value of 103K USD a year later is 100K USD at present at 3% interest rate.
This is the concept of DCF. This 3% interest rate is called discount rate in DCF method and WACC is generally applied to discount rate in corporate finance.
100K USD = Present Value (PV) of 100K USD @ 3% discount rate
NPV means total PV
An example of DCF@
Investment@@100K USD
FCF / every year@@20K USD
Discount Rate@6%
Period@7 years
Y0
Y1
Y2
Y3
Y4
Y5
Y6
Y7
Investment
100







FCF

20
20
20
20
20
20
20
Discount Rate
(@6%)

0.94
0.89
0.84
0.79
0.75
0.70
0.67
PV

18.9
17.8
16.8
15.8
14.9
14.1
13.3
NPV
100
81.1
63.3
46.5
30.7
15.8
1.7
11.6
In this case, NPV is plus within the considered period so this investment is valuable unless there are any other problems apart from finance. Considered period is usually decided by life cycle of the project or the product. Normally, it is 510 years but sometimes 2 years, for example for semiconductor products.
Caution when DCF is used@
DCF is very theoretical method to calculate value. However, cash flow cannot be accurately calculated so it is normally calculated in some scenarios such as optimistic scenario, interim scenario and pessimistic scenario. Through this scenario analysis, acceptable risk would be clarified quantitatively.
Advertisement
<<
>>
Finance
Principle of Finance FCF (Free Cash Flow) DCF (Discount Cash Flow) WACC Beta Unlevered Beta IRR Terminal Value Disadvantages of WACC APV (Adjusted present value) Method
Making Portfolio and Diversification of Risk 1
Making Portfolio and Diversification of Risk 2
Return analysis by DCF 1
Return analysis by DCF 2
Important Indicator of DCF
Optimized Debt Equity Ratio
Tax Shield by Debt
Types of Debt
Policy of Dividend
Relationship between Policy of Dividend & Stock Price
Relationship between Own Shares Purchase & Stock Price
Investment to raise Stock Price
Bond
CouponBearing Bond
Discount Bond
Bond with Warrant
Comparison of Yield Rate among Several Bonds
Securitization
Project Finance
M&A
Effect of M&A
Synergy Analysis
Financing in M&A
Process of Purchasing Stock Price in M&A
Types of Selling Business
Spinoff
Tracking Stock
Curve Out
LBO (Leveraged Buy Out)
MBO (Management Buy Out)
PPA (Purchase Price Allocation)
PMI (Post Merger Integration)