Discounted cash flow (DCF) is one of the approaches of business valuation under the income approach. DCF uses a discount rate to derive the net present value of future cash flows. The commonly used discount rate is the Weighted Average Cost of Capital (WACC). Discounted cash flow shows how much should be invested to reach the desired earnings in the future. Many investors used this method as it utilizes the cash flow to predict future returns, which is one of the factors that investors and financial analysts are looked upon when evaluating businesses for possible investment options. However, DCF is a complicated approach and requires a deep understanding of the formula used for this approach. To understand more below is the formula to compute for the Discounted Cash Flow. Discounted Cash Flow Formula and Example The formula is presented in detail with an example below to explain better how the computation in Excel for Discounted Cash Flow works. DCF = CF1/(1+r)1 + CF2/(1+r)2 + CFn/(1+r)n where:
Example: Given that the five-year future cash flows are $170,000, $200,000, $250,000, $330,000, and $400,000 with the discount rate of 7% and investment cost of $750,000. The total net present value of the future cash flows amounted to $1,074,591, which is higher by $324,591 than the investment cost. It can be projected that given the positive discounted cash flow, the proposed project is worth pursuing. Excel for discounted cash flow is an invaluable tool in computing for business valuation. It is a widely utilized and trusted approach since it uses the cash flows and the time value of money, which shows how much investors would get if invested in companies with similar risks. It would be helpful to use alongside other business valuations to strengthen the result and provide more reliable forecasts. Widely available financial model templates are available online, incorporating the discounted valuation method and other valuation approaches in the projection. eFinancialModels industry experts prepared financial model templates are easy to use and manipulate, which can save you time and resources than prepared from scratch on your own.
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