Enter the forecasted cash flows in the selected currency.
Enter the discount rate as a percentage.
Enter the forecast period in years.
Enter the terminal value in the selected currency.
History:

Explanation

What is Discounted Cash Flow (DCF)?

Discounted Cash Flow (DCF) is a financial valuation method used to estimate the value of an investment based on its expected future cash flows. The DCF method considers the time value of money, which means that a dollar today is worth more than a dollar in the future due to its potential earning capacity.

How to Calculate DCF?

The DCF calculation involves the following formula:

Discounted Cash Flow (DCF) is calculated as:

§§ DCF = \sum_{t=1}^{n} \frac{CF_t}{(1 + r)^t} + \frac{TV}{(1 + r)^n} §§

where:

  • § DCF § — Discounted Cash Flow
  • § CF_t § — Cash flow in year t
  • § r § — Discount rate (as a decimal)
  • § n § — Total number of years (forecast period)
  • § TV § — Terminal value at the end of the forecast period

Key Terms

  • Cash Flow (CF): The net amount of cash being transferred into and out of a business. Positive cash flow indicates that a company is generating more cash than it is spending.

  • Discount Rate (r): The interest rate used to discount future cash flows back to their present value. It reflects the opportunity cost of capital and the risk associated with the investment.

  • Forecast Period (n): The number of years over which the cash flows are projected.

  • Terminal Value (TV): The estimated value of an investment at the end of the forecast period, accounting for all future cash flows beyond that point.

Example Calculation

Let’s say you expect to receive the following cash flows over the next five years from an investment:

  • Year 1: $1,000
  • Year 2: $1,200
  • Year 3: $1,500
  • Year 4: $1,800
  • Year 5: $2,000

Assuming a discount rate of 10% and a terminal value of $5,000, the DCF calculation would be as follows:

  1. Calculate the present value of each cash flow:

    • Year 1: § \frac{1000}{(1 + 0.10)^1} = 909.09 §
    • Year 2: § \frac{1200}{(1 + 0.10)^2} = 991.74 §
    • Year 3: § \frac{1500}{(1 + 0.10)^3} = 1123.60 §
    • Year 4: § \frac{1800}{(1 + 0.10)^4} = 1235.73 §
    • Year 5: § \frac{2000}{(1 + 0.10)^5} = 1241.83 §

  2. Calculate the present value of the terminal value:

    • Terminal Value: § \frac{5000}{(1 + 0.10)^5} = 3105.10 §

  3. Sum all present values to get the DCF:

    • DCF = 909.09 + 991.74 + 1123.60 + 1235.73 + 1241.83 + 3105.10 = $10301.09

When to Use the DCF Calculator?

  1. Investment Valuation: Assess the value of potential investments based on expected cash flows.

    • Example: Evaluating a new project or business acquisition.

  2. Financial Analysis: Analyze the financial health of a company by estimating its intrinsic value.

    • Example: Comparing the DCF value to the current market price of a stock.

  3. Budgeting and Forecasting: Help in making informed decisions about future cash flows and investments.

    • Example: Planning for capital expenditures or new product launches.

  4. Mergers and Acquisitions: Determine the fair value of a target company during negotiations.

    • Example: Assessing the value of a company being acquired.

  5. Real Estate Investments: Evaluate the potential return on investment for property purchases.

    • Example: Estimating future rental income and property appreciation.

Practical Examples

  • Corporate Finance: A company may use the DCF calculator to evaluate whether to invest in a new product line by estimating future cash flows and comparing them to the initial investment.

  • Personal Finance: An individual might use the DCF calculator to assess the value of a rental property by estimating future rental income and potential appreciation.

  • Venture Capital: Investors can use DCF to determine the value of startups based on projected cash flows and exit strategies.

Use the calculator above to input different values and see the DCF change dynamically. The results will help you make informed decisions based on the data you have.