Discounted Cash Flow - DCF

AAA

DEFINITION of 'Discounted Cash Flow - DCF'

A valuation method used to estimate the attractiveness of an investment opportunity. Discounted cash flow (DCF) analysis uses future free cash flow projections and discounts them (most often using the weighted average cost of capital) to arrive at a present value, which is used to evaluate the potential for investment. If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity may be a good one.

Calculated as:

 

Discounted Cash Flow (DCF)

Also known as the Discounted Cash Flows Model.

INVESTOPEDIA EXPLAINS 'Discounted Cash Flow - DCF'

There are many variations when it comes to what you can use for your cash flows and discount rate in a DCF analysis. Despite the complexity of the calculations involved, the purpose of DCF analysis is just to estimate the money you'd receive from an investment and to adjust for the time value of money.

Discounted cash flow models are powerful, but they do have shortcomings. DCF is merely a mechanical valuation tool, which makes it subject to the axiom "garbage in, garbage out". Small changes in inputs can result in large changes in the value of a company. Instead of trying to project the cash flows to infinity, terminal value techniques are often used. A simple annuity is used to estimate the terminal value past 10 years, for example. This is done because it is harder to come to a realistic estimate of the cash flows as time goes on.

How to use DCF to value stock market? Read DCF Valuation: The Stock Market Sanity Check and Using DCF In Biotech Valuation

VIDEO

RELATED TERMS
  1. Net Present Value - NPV

    The difference between the present value of cash inflows and ...
  2. Equivalent Annual Annuity Approach ...

    One of two methods used in capital budgeting to compare mutually ...
  3. Composite Cost Of Capital

    A company's cost to borrow money given the proportional amounts ...
  4. Discounted After-Tax Cash Flow

    An approach to valuing an investment that looks at the amount ...
  5. Asset Valuation

    A method of assessing the worth of a company, real property, ...
  6. Free Cash Flow - FCF

    A measure of financial performance calculated as operating cash ...
Related Articles
  1. Fundamental Analysis

    How is impairment loss calculated?

    Learn how companies re-evaluate their assets and compare them against book values to recognize impairment and why this strategy is important.
  2. Fundamental Analysis

    Discounted Cash Flow Analysis

    Find out how analysts determine the fair value of a company with this step-by-step tutorial and learn how to evaluate an investment's attractiveness for yourself.
  3. Investing Basics

    Pin Down Stock Price With Real Options

    How can you assign a value to what a company may do with its business in the future? We explain how it works.
  4. Investing Basics

    DCF Valuation: The Stock Market Sanity Check

    Calculate whether the market is paying too much for a particular stock.
  5. Investing Basics

    Understanding The Time Value Of Money

    Find out why time really is money by learning to calculate present and future value.
  6. Investing

    Using DCF In Biotech Valuation

    Valuing firms in this sector can seem like a black art, but there is a systematic way to pin a price on potential.
  7. Markets

    Valuing A Stock With Supernormal Dividend Growth Rates

    If these calculations are off, it could drastically change the value of the shares.
  8. Fundamental Analysis

    Top 3 Pitfalls Of Discounted Cash Flow Analysis

    The DCF method can be difficult to apply to real-life valuations. Find out where it comes up short.
  9. Entrepreneurship

    How do I value the shares that I own in a private company?

    Share ownership in a private company is usually quite difficult to value due to the absence of a public market for the shares. Unlike public companies that have the price per share widely available, ...
  10. Fundamental Analysis

    Taking Stock Of Discounted Cash Flow

    Learn how and why investors are using cash flow-based analysis to make judgments about company performance.

You May Also Like

Hot Definitions
  1. Deferred Revenue

    Advance payments or unearned revenue, recorded on the recipient's balance sheet as a liability, until the services have been ...
  2. Multinational Corporation - MNC

    A corporation that has its facilities and other assets in at least one country other than its home country. Such companies ...
  3. SWOT Analysis

    A tool that identifies the strengths, weaknesses, opportunities and threats of an organization. Specifically, SWOT is a basic, ...
  4. Simple Interest

    A quick method of calculating the interest charge on a loan. Simple interest is determined by multiplying the interest rate ...
  5. Special Administrative Region - SAR

    Unique geographical areas with a high degree of autonomy set up by the People's Republic of China. The Special Administrative ...
  6. Annual Percentage Rate - APR

    The annual rate that is charged for borrowing (or made by investing), expressed as a single percentage number that represents ...
Trading Center