A popular mechanism of measuring the discounted value of the future cash flow:
| (1) | \mbox{DCF}_i = \frac{\mbox{CF}_{t_i}}{(1+r)^i} |
| (2) | \mbox{DCF} = \sum_{i=1}^n \mbox{DCF}_i = \frac{\mbox{CF}_1}{(1+r)} + \frac{\mbox{CF}_2}{(1+r)^2} + \frac{\mbox{CF}_3}{(1+r)^3} + ... |
where
n | total number of accounting periods |
|---|---|
i= 0, 1, 2, 3, ... | running number of accounting period (usually 1 year) |
r | discount rate |
\mbox{CF}_i | free cash flow generated during the i-th accounting period |
\mbox{DCF}_i | discounted free cash flow flow generated during the i-th accounting period |
The main idea of DCF is that value of cash today is higher than value of cash tomorrow because immediate cash can be invested in readily available low-risk investment market opportunities and assure a certain profit. The loss of the cash value is controlled by discount rate.
Investor normally would like to compare DCF against
DCF is normally used
See also
[ Profitability Index (PI) ] [ Net Present Value (NPV) ]