Discounted Cash Flow (DCF) is a valuation method in finance that estimates the value of an investment by forecasting future cash flows and discounting them to present value. This technique considers the time value of money and risk, focusing on cash flows rather than accounting profits. It's used across various financial disciplines, including corporate finance and equity research, and is crucial for capital budgeting and company valuations. The DCF model's accuracy depends on the projected cash flows and the chosen discount rate.
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DCF is a technique used in finance to estimate the attractiveness of an investment opportunity by forecasting future cash flows and discounting them to their present value
Risk and Time Value of Money
The discount rate in DCF reflects the risk and time value of money, which recognizes that money today is worth more than the same amount in the future
The discount rate is used to discount future cash flows in DCF
The DCF model includes estimating future cash flows, determining the appropriate discount rate, and calculating the terminal value
DCF is used in various financial disciplines, such as corporate finance, investment banking, and equity research
DCF is used to evaluate the profitability of long-term investments
DCF is used to determine the value of companies and financial assets by converting future cash flows into present value
The DCF valuation process involves projecting cash flows, applying a discount rate, and estimating the terminal value
The forecast horizon in DCF should be as long as the asset is expected to generate cash flows
The DCF formula, \( PV = \frac{CF}{(1 + r)^n} \), is used to calculate the present value of an investment by discounting expected cash flows
The accuracy of DCF valuation depends on the quality of assumptions about future cash flows and the discount rate
Sensitivity analysis is used to understand how changes in assumptions impact the DCF valuation
DCF results should be compared to the current market price and the chosen discount rate to assess the risk associated with the investment
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In DCF analysis, the discount rate accounts for the ______ and the ______ ______ of money, which is based on the idea that current funds are more valuable than future sums.
risk
time value
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A critical part of the DCF model is the calculation of the ______ ______, which estimates the value of cash flows after the forecast period ends.
terminal value
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Purpose of DCF in capital budgeting
Evaluates profitability of long-term investments by calculating present value of future cash flows.
