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Discounted Cash Flow

Some investors use Discounted Cash Flow (DCF) to value companies. The methodology involves forecasting future net cash flows into a business and discounting them using a discount rate.

As an example, Company A has forecast cash flows of £10 in year one, £20 in year two, £50 in year three and £500 in year 4 (as it is planned to be sold to another company). For this exercise, the discount rate is 5%. The discounted cash flow valuation today (the net present value) is

10 / (1+5%) + 20 / (1+5%) x (1+5%) + 50 / (1+5%) x (1+5%) x (1+5%) + 500 / (1+5%) x (1+5%) x (1+5% )x (1+5%)

= £482.21

 

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