Valuation
Discounted cash flow
Also called DCF
Valuing a business by estimating its future cash flows and converting them to today’s money.
How it works
DCF is the only valuation method that is theoretically complete: an asset is worth the cash it will produce, adjusted for the fact that money later is worth less than money now.
In practice it is highly sensitive to its inputs. Small changes in the growth rate or the discount rate produce enormous changes in the answer, most of which sits in the terminal value.
Where it misleads people
A DCF can be made to produce almost any answer by adjusting assumptions within a defensible range. Its real value is in showing what a price implies about the future, not in producing a target.
Formula
Value = Σ [cash flow in year n ÷ (1 + discount rate)ⁿ] + terminal value discounted backRelated terms
- Discount rateThe rate used to convert future money into what it is worth today.
- Terminal valueThe estimated value of all cash flows beyond the explicit forecast period in a valuation.
- WACCThe blended cost of a company’s debt and equity funding, weighted by how much of each it uses.
- Free cash flowCash left over after paying for the investment needed to maintain and grow the business.
- Reverse DCFWorking backwards from the share price to find what growth the market is already assuming.
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Educational reference only. Nothing here is investment advice or a recommendation to buy or sell anything, and tax treatment depends on your own circumstances and the country you are in.