Understanding DCF (Discounted Cash Flow) Analysis
The core DCF principle: a dollar today is worth more than a dollar tomorrow, because it can be invested to earn returns.
Formula
PV = CF1/(1+r) + CF2/(1+r)^2 + CF3/(1+r)^3 + ...
Where PV = present value, CF = cash flow, r = discount rate.
3-Step Method
- Estimate future cash flows: project cash flows for each year.
- Choose a discount rate: typically the WACC (weighted average cost of capital), often 8-12%.
- Sum discounted values: divide each cash flow by (1+r)^t and add them up.
Example
3 years of 10,000 EUR cash flow at 8% discount rate:
- Year 1: 10,000 / 1.08 = 9,259 EUR
- Year 2: 10,000 / 1.1664 = 8,573 EUR
- Year 3: 10,000 / 1.2597 = 7,938 EUR
- Total present value: 25,770 EUR