Discounted cash flow
Discounted cash flow is a valuation approach that estimates an asset's worth as the present value of its expected future cash flows, each discounted at a risk-adjusted rate to reflect the time value of money.
FrameworkDCF valuation
See it move
A project pays €40,000 a year for three years; at a 10% discount rate those flows are worth €36,364, €33,058 and €30,052 today, summing to €99,474. Against a €90,000 outlay, net present value is €9,474 — positive, so the project creates value even after future cash is discounted back to today's terms.
The formula
Variables
- cash flow in period t (€)
- discount rate (required return) (decimal)
- period number
- total number of periods
Each future cash flow is divided by (1 + r)ᵗ to convert it to present value; summing all present values gives the asset's intrinsic worth.
Check yourself
A DCF valuation model uses cash flows rather than accounting profit as its inputs. Which of the following best explains why cash flows are preferred?