Discounted cash flow analysis is a method which is used for valuing a business or a project, a company or an asset with estimated future cash flows that are discounted to give their present values.

1. Discounted Cash Flow Valuation Example
Discounted cash flow analysis is a method which is used for valuing a business or a
project, a company or an asset with estimated future cash flows that are discounted
to give their present values.
Discounted cash flow analysis depends on one of the theories in economy which is
the time value of money. According to this theory, the present value of money is
more than the future value of money. In other words, if you have $100 today and
assuming that you’ll earn 10% income in one year, next year around the same time,
you’ll have $110 in your hand. In other words, $100 today is more valuable than
$100 after one year.
Accordingly, the theory of discounted cash flow is used to find out the amount of
investment that is required to earn a certain amount of return continuously for a
number of years before the invested amount is realized completely and make profits.
The formula for discounted cash flow is
DCF = CF1/ (1+r)1
+ CF2/ (1+r)2
+ CF3/ (1+r)3
+ …..+ CFn/ (1+r)n
Where, DCF is discounted cash flow and r is the rate of discount.
Examples
Here is an example for discounted cash flow.
Q. A company is considering replacing a machine with a new one. The company will
have to pay out $20,000 and once the machine is installed and running, the company
is expecting to generate a cash flow of $10,000, $15,000 and $20,000 respectively in
the first 3 years. If we assume a discount of 10%, what would be net present value
for the machine.
Using the above formula, we can calculate the net present value to be
10,000/(1+0.10)1
+ 15,000/(1+0.10)2
+ 20,000/(1+0.10)3
=
10000/ 1.1 + 15000/1.21 + 20,000/1.33 =
9090 + 12397 + 15027 = 36514
36514-20000 = 16514.

2. Q. A business is trying to bring out a new product for which an initial investment of
$125000 is needed. The business is expecting to earn $30,000, $20000, $45000,
$70000, $30000 and $20000 in the first six years. A discount of 12% has been taken.
Calculate the NPV.
Using the formula for DCF, we can calculate the net present value to be
30,000/(1+0.12)1
+ 20,000/(1+0.12)2
+ 45,000/(1+0.12)3
+ 70,000/(1+0.12)4
+
30,000/(1+0.12)5
+ 20,000/(1+0.12)6
=
26786 + 15944 + 32030 + 44486 + 17021 + 10133 = 146400