Discounted Cash Flow (DCF)
Discounted Cash Flow (DCF) is a financial analysis technique used to determine the present value of a future stream of cash flows. It is used to evaluate the potential profitability of an investment or project by discounting the future cash flows to their present value. The discount rate used is typically the cost of capital, which is the rate of return that a company must earn to satisfy its investors. By discounting the future cash flows, the present value of the investment or project can be determined.
History of Discounted Cash Flow
Discounted Cash Flow (DCF) was first developed by Irving Fisher in the early 1900s. Fisher was a prominent American economist who developed the theory of capital and interest. He was also the first to introduce the concept of discounting future cash flows. Since then, DCF has become a widely used tool in financial analysis and decision-making. It is used by companies to evaluate the potential profitability of investments and projects, and by investors to determine the value of a company or asset.
Comparison of Discounted Cash Flow and Other Methods
| Method | Pros | Cons |
|---|---|---|
| Discounted Cash Flow | Provides a more accurate assessment of future cash flows; takes into account the time value of money. | Requires accurate estimates of future cash flows; can be difficult to calculate. |
| Net Present Value | Provides a more accurate assessment of future cash flows; takes into account the time value of money. | Requires accurate estimates of future cash flows; can be difficult to calculate. |
| Payback Period | Simple to calculate; provides a quick assessment of the investment. | Does not take into account the time value of money; does not consider cash flows beyond the payback period. |
Summary
Discounted Cash Flow (DCF) is a financial analysis technique used to determine the present value of a future stream of cash flows. It is used to evaluate the potential profitability of an investment or project by discounting the future cash flows to their present value. The discount rate used is typically the cost of capital, which is the rate of return that a company must earn to satisfy its investors. By discounting the future cash flows, the present value of the investment or project can be determined. For more information about DCF, visit Investopedia, The Balance, and Investing Answers.
See Also
- Net Present Value
- Payback Period
- Internal Rate of Return
- Cost of Capital
- Time Value of Money
- Capital Budgeting
- Cash Flow Statement
- Discount Rate
- Net Cash Flow
- Opportunity Cost
