Discounted Cash Flow (DCF)

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Discounted Cash Flow (DCF)

Explanation: Discounted Cash Flow (DCF) is a valuation method used to estimate the value of an investment based on its expected future cash flows. It involves forecasting the future cash flows generated by an investment, such as a project, business, or financial asset, and then discounting those cash flows back to their present value using a discount rate. By discounting future cash flows, DCF takes into account the time value of money, which reflects the principle that a rupee received today is worth more than a rupee received in the future due to its potential earning capacity if invested.

Example: Let’s say you’re considering buying a rental property. You estimate it will bring in 50,000 rupees in rent every year for the next 10 years, and then you plan to sell it for 600,000 rupees. Using a discount rate of 8%, you figure out how much those future cash amounts are worth today by “discounting” them. So, the 50,000 rupees you’ll get next year might be worth around 46,296 rupees today when you factor in the time value of money. You do this for each year’s rent and the sale price, then add up all those present values. If the total is more than what you’d pay for the property, it could be a good investment. DCF helps you see if an investment’s future potential is worth its cost in today’s terms.

Discount Rate

8%

Time

Cash Flow

Present Value

Type

Year 1

50,000.00

46,296.30

Rent

Year 2

50,000.00

42,866.94

Rent

Year 3

50,000.00

39,691.61

Rent

Year 4

50,000.00

36,751.49

Rent

Year 5

50,000.00

34,029.16

Rent

Year 6

50,000.00

31,508.48

Rent

Year 7

50,000.00

29,174.52

Rent

Year 8

50,000.00

27,013.44

Rent

Year 9

50,000.00

25,012.45

Rent

Year 10

6,50,000.00

3,01,075.77

Rent + Sale

Total Present Value

6,13,420.16

DCF is widely used in finance and investment analysis for making investment decisions, determining the fair value of assets, and evaluating the feasibility of projects. It provides a systematic framework for assessing the intrinsic value of an investment based on its expected future cash flows, helping investors make informed decisions and allocate capital efficiently.

You can calculate the DCF value for any discount rate with our DCF calculator on Radar in the DCF section.

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