DEFINITION of 'Discounted After-Tax Cash Flow'

The discounted after-tax cash flow method is an approach to valuing an investment by assessing the amount of money generated and taking into account the cost of capital and the investor's marginal tax rate. Discounted after-tax cash flow is similar to simple discounted cash flow (DCF), but tax implications are also taken into consideration.

BREAKING DOWN 'Discounted After-Tax Cash Flow'

The discounted after-tax cash flow approach is mostly used in real estate valuation to determine whether a particular property is likely to be a good investment. Investors must consider depreciation, the tax bracket of the entity that will own the property, and any interest payments when using this valuation method. It is a calculation of net cash flow from a property after taxes and financing costs each year have been factored in. The cash flow is discounted at the required rate of return of the investor to find the present value of the after-tax cash flows. If the present value of the after-tax cash flow is higher than the cost of investment, then the investment may be worth taking.

Since the discounted after-tax cash flow is calculated after tax, depreciation, even though it is not an actual cash flow, must be used to determine the tax charge. Depreciation is a non-cash expense that reduces taxes and increases cash flow. It is usually subtracted from net operating income to derive the after-tax net income, and then added back in to reflect the positive impact it has on the after-tax cash flow.

Because there are many different methods for valuing real estate investment, and each method has its shortcomings, investors should not rely solely on discounted after tax cash flow to make a decision. To examine the property's value from multiple perspectives, you can also use other methods of real estate valuation such as the cost approach, sale comparison approach (SCA), and income approach.

The discounted after-tax cash flow can be used to calculate the profitability index, a ratio that evaluates the relationship between the costs and benefits of a proposed project or investment. The profitability index, or benefit-cost ratio, is calculated by dividing the present value of the discounted after-tax cash flow by the cost of the investment. The rule of thumb asserts that a project with a profitability index ratio equal to or greater than one is a potential profitable investment opportunity. In other words, if the present value of the after-tax cash flow is equal to or higher than the cost of the project, the project may be worth undertaking.

The discounted after-tax cash flow is also used to calculate the simple payback and discounted payback period of an investment, allowing an investor to determine the length of time it would take for a project to recover the initial amount invested in it.

RELATED TERMS
  1. After-Tax Return On Sales

    After-tax return on sales is a metric measuring profitability.
  2. After-Tax Return

    An after-tax return is the profit that remains after taxes are ...
  3. Free Cash Flow Yield

    Free cash flow yield is a financial ratio that standardizes the ...
  4. Cash Flow Per Share

    A measure of a firm's financial strength, calculated as: Cash ...
  5. Cash Flow

    Cash flow is the net amount of cash and cash-equivalents being ...
  6. Operating Cash Flow (OCF)

    Operating Cash Flow (or OCF) is a measure of the amount of cash ...
Related Articles
  1. Investing

    Evaluating A Statement Of Cash Flows

    The metrics for the Statement of Cash Flows is best viewed over time.
  2. Investing

    Free Cash Flow Yield: The Best Fundamental Indicator

    Cash in the bank is what every company strives to achieve. Find out how to determine how much a company is generating and keeping.
  3. Retirement

    How After-Tax Rollovers Affect Your IRA

    Consolidating retirement assets? Make sure you account for pre-tax and after-tax assets separately.
  4. Investing

    Analyzing the Price-to-Cash-Flow Ratio

    Find out how analyzing the price-to-cash-flow ratio can help you make batter investment decisions.
  5. Investing

    Operating Cash Flow: Better Than Net Income?

    Differences between accrual accounting and cash flows show why net income is easier to manipulate.
  6. Investing

    Cash Flow Indicator Ratios

    Learn about the operating cash flow to sales ratio, free cash flow to operating cash flow ratio and free cash flow coverage ratio.
  7. Investing

    How to choose the best stock valuation method

    There are many valuation methods available to investors, each with unique characteristics. Here, we'll explore the most common valuation methods – and when to use them.
RELATED FAQS
  1. What is the formula for calculating net present value (NPV) in Excel?

    Net present value is used to estimate the profitability of projects or investments. Here's how to calculate NPV using Microsoft ... Read Answer >>
  2. How do you use DCF for real estate valuation?

    Learn how discounted cash flow analysis is used for real estate valuation and the various factors that go into calculating ... Read Answer >>
  3. What is the difference between the cost of capital and the discount rate?

    Learn about the differences between the cost of capital and the discount rate as they relate to estimating a required return ... Read Answer >>
  4. What is the difference between cash flow and fund flow?

    See how cash flow and fund flow differ from each other, and why fund flow can be used very differently by accountants and ... Read Answer >>
  5. What is the difference between cash flow and free cash flow?

    Learn about the main differences between cash flow and free cash flow. In addition to the differences, learn how to calculate ... Read Answer >>
  6. How should I evaluate a company with negative cash flow investing activities?

    Negative cash flow from investing activities should be evaluated since it could be a warning sign. However, it can also mean ... Read Answer >>
Hot Definitions
  1. Socially Responsible Investment - SRI

    Socially responsible investing looks for investments that are considered socially conscious because of the nature of the ...
  2. Business Cycle

    The business cycle describes the rise and fall in production output of goods and services in an economy. Business cycles ...
  3. Futures Contract

    An agreement to buy or sell the underlying commodity or asset at a specific price at a future date.
  4. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  5. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  6. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
Trading Center