about DCF
what does DCF means? how to use it? how to apply it to evaluate stock? is it important?
Answers
957 points
CUWu answered one year ago …
DCF stands for Discounted Cash Flow. It's the process of discounting a future cash flow to the present value of money. An easier way of thinking about it is, it's the REVERSE of the growth equation.
Here's a quick example of the growth equation:
$10 will grow by 100% per year for 5 years, in the 5th year that original $10 will be worth $320.
DCF would be along the lines of taking $320 and discounting it back by 100% per annum...that would leave you with $10.
A financial calculator (or an internet based DCF calculator) would be helpful.
So when you use DCF for stock/bond/asset valuation you're basically adding up the sum of ALL the future cash flows of a company and then discounting it. That gives you the current value of that particular asset. As you start to learn more about this concept it'll probably help to study it for bonds first (being that all future cash flows have already been determined).
Hope that helped. :)
508 points
John answered one year ago …
In finance, the discounted cash flow (or DCF) approach describes a method to value a project, company, or financial asset using the concepts of the time value of money. All future cash flows are estimated and discounted to give them a present value. The discount rate used is generally the appropriate cost of capital, and incorporates judgments of the uncertainty (riskiness) of the future cash flows.
Discounted cash flow analysis is widely used in investment finance, real estate development, and corporate financial management.
The discounted cash flow formula is derived from the future value formula for calculating the time value of money and compounding returns.
FV = PV * (1+i)^n
The simplified version of the Discounted cash flow equation (for one cash flow in one future period) is expressed as:
DPV = FV / (1+d)^n
where
* DPV is the discounted present value of the future cash flow (FV), or FV adjusted for the opportunity cost of future receipts and risk of loss;
* FV is the nominal value of a cash flow amount in a future period;
* d is the discount rate, which is the opportunity cost plus risk factor (or the time value of money: "i" in the future-value equation); * n is the number of discounting periods used (the period in which the future cash flow occurs). I.e. if the receipts occur at the end of year 1, n will be equal to 1; at the end of year 2, 2—likewise, if the cash flow happens instantly, n becomes 0, rendering the expression an identity (DPV=FV).
For each future cash flow (FV) at any time period (t) for all time periods. The sum can then be used as a net present value figure or used to further calculate the internal rate of return for a cash flow pattern over time.
1130 points
sundarkambam answered one year ago …
Link :http://www.valuebasedmanagement.net/methods_dcf.html
Discounted Cash Flow (DCF) is what someone is willing to pay today in order to receive the anticipated cash flow in future years. DCF means converting future earnings to today's money. The future cash flows must be discounted in order to express their present values in order to properly determine the value of a company or project under consideration as a whole.
The DCF for an investment is calculated by estimating the cash you will have to pay out and the cash you think you will receive back. The times that you expect to receive the payments must also be estimated. Each cash transaction must then be discounted by the opportunity cost of capital over the time between now and when you will pay or receive the cash.
For example, if inflation is 6%, the value of your money would halve every ±12 years. If you are expecting an asset to give you an income of $30.000 a year in 12 years time, that income stream would be worth $15.000 today if inflation was 6% for the period. We have just discounted the cash flow of $30.000: it's only worth $15.000 to you at this moment.
The DCF method is an approach to valuation, whereby projected future cashflows are "discounted" at an interest rate (also called: "rate of return"), that reflects the perceived riskiness of the cashflows. The discount rate reflects two things:
1. the time value of money (investors would rather have cash immediately than having to wait and must therefore be compensated by paying for the delay)
2. a risk premium that reflects the extra return investors demand because they want to be compensated for the risk that the cash flow might not materialize after all.
History: Discounted cash flow was first formally articulated in John Burr Williams' 1938 text 'The Theory of Investment Value' after the market crash of 1929 and before auditing and pubic accounting were mandated by the SEC. As a result of the crash, investors were wary of relying on reported income, or indeed, any measures of value besides cash. Throughout the 1980s and 1990s, the value of cash and physical assets became steadily less well correlated with the total value of the company (as determined by the stock market). By some estimates, tangible assets dropped to less than one-fifth of corporate value (intangible assets such as customer relationships, patents, proprietary business models, channels, etc. comprising the remaining four-fifths).
