discounted cash flow

• Discounted Cash Flow

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Mergers and acquisitions - Business valuation

1 discounted cash flow (DCF) valuation


Business value - Philosophy

1 While it would be very desirable to translate all forms of business value to a

single economic measure (e.g., discounted cash flow), many practitioners and

theorists believe this is either not feasible or theoretically impossible. Therefore,

advocates of business value believe that the best approach is to measure and

manage multiple forms of value as they apply to each stakeholder group.


Business value - Shareholder Value

1 For a privately held company, the value of the firm after debt must be

estimated using one of several valuation methods, s.a. discounted

cash flow or others.


Ant colony optimization - Others

1 *Discounted cash flows in project schedulingW. N. Chen, J. ZHANG and

H. Chung, Optimizing Discounted Cash Flows in Project Scheduling--An Ant Colony Optimization Approach, IEEE Transactions on Systems, Man,

and Cybernetics--Part C: Applications and Reviews Vol.40 No.5 pp.64-77,

Jan. 2010.


Valuation (finance) - Valuation overview

1 #Absolute value models that determine the present value of an asset's expected future cash flows.

These kinds of models take two general forms: multi-period models

such as discounted cash flow models or single-period models such as the Gordon model. These models rely on

mathematics rather than price observation.


Valuation (finance) - Business valuation

1 For a Valuation using discounted cash flows|valuation using the

discounted cash flow method, one first estimates the future cash flows

from the investment and then estimates a reasonable discount rate

after considering the riskiness of those cash flows and interest rates in the capital markets. Next, one makes a calculation to compute the present

value of the future cash flows.https://store.theartofservice.com/the-discounted-cash-flow-toolkit.html

Valuation (finance) - Net asset value method

1 This method can also be used to value heterogeneous portfolios of investments, as well as nonprofits,

for which discounted cash flow analysis is not relevant


Levelised energy cost - Cost factors

1 To evaluate the total cost of production of electricity, the streams

of costs are converted to a net present value using the time value of money. These costs are all brought

together using discounted cash flow.


Fossil-fuel power station - Relative cost by generation source

1 These costs occur over the 30–50 year life of the fossil fuel power

plants, using discounted cash flows. In general large fossil plants are attractive due to their low initial

capital costs—typically around £750–£1000 per kilowatt electrical

compared to perhaps £1500 per kilowatt for onshore wind.


Economics of new nuclear power plants - Capital costs

1 The discounted cash flow|discount rate chosen to cost a nuclear power

plant's capital over its lifetime is arguably the most sensitive parameter to overall costs.


Patent valuation - Income-based method

1 # Discounted cash flow method: This method aims to estimate future cash flows, which are projected and after

discounted by applying an appropriate discount factor. The main source of information to estimate the cash flows is generally the business plan of the company that exploits or

intends to exploit the asset.


ILUC - EPA Renewable Fuel Standard

1 EPA's draft analysis stated that ILUC can produce significant near-term GHG emissions due to land conversion, but that biofuels can pay these back over subsequent years. EPA highlighted two scenarios, varying the time

horizon and the discounted cash flow|discount rate for valuing emissions. The first assumed a 30 year time period uses a 0 percent discount rate (valuing emissions equally regardless of timing). The second scenario used a 100 year

time period and a 2% discount rate.


Internal rate of return

1 It is also called the discounted cash flow rate of return (DCFROR).Project Economics and Decision Analysis, Volume I: Deterministic Models,

M.A.Main, Page 269 In the context of savings and loans the IRR is also called the effective interest rate


Internal rate of return - Problems with using internal rate of return

1 Since IRR does not consider cost of capital, it should not be used to

compare projects of different duration. Modified Internal Rate of

Return (MIRR) does consider cost of capital and provides a better

indication of a project's efficiency in contributing to the firm's discounted

cash flow.


Outline of finance - Fundamental financial concepts

1 ** Discounted cash flow


Net present value

1 NPV is a central tool in discounted cash flow (DCF) analysis and is a

standard method for using the time value of money to appraise long-term

projects


Stock valuation - Fundamental criteria (fair value)

1 The most theoretically sound 'stock valuation method', called income valuation or the

discounted cash flow ('DCF') method, involves 'discounting of the profits' (dividends,

earnings, or cash flows) the stock will bring to the stockholder in the foreseeable future, and

a final value on disposal.William F. Sharpe, Investments, Prentice-Hall, 1978, pp. 300

et.seq. The discounted rate normally includes a risk premium which is commonly based on

the capital asset pricing model.


Stock valuation - Fundamental criteria (fair value)

1 Contested inputs included the terminal growth rate, the equity

premium puzzle|equity risk premium, and

beta.[http://blogs.law.harvard.edu/corpgov/2010/07/16/delaware-provides-guidance-regarding-discounted-cash-

flow-analysis/ Delaware Provides Guidance Regarding Discounted Cash

Flow Analysis]https://store.theartofservice.com/the-discounted-cash-flow-toolkit.html

Stock valuation - Limited high-growth period approximation

1 When a stock has a significantly higher growth rate than its peers, it is sometimes assumed that the earnings growth rate will be sustained for a short time (say, 5 years),

and then the growth rate will Regression toward the mean|revert to the mean. This is probably the most rigorous approximation

that is practical.[http://www.moneychimp.com/articles/valuation/dcf.htm Discounted Cash Flow

Calculator for Stock Valuation]


Microeconomics - Opportunity cost

1 This kind of reasoning is a very important part of the calculation of discount rates in discounted cash

flow investment valuation methodologies


Corporate finance - Investment and project valuation

1 Harvey each project's value will be estimated using a discounted cash

flow (DCF) valuation, and the opportunity with the highest value, as measured by the resultant net

present value (NPV) will be selected (applied to Corporate Finance by Joel Dean (economist)|Joel Dean in 1951)


Corporate finance - Investment and project valuation

1 The NPV is greatly affected by the discounted cash flow|

discount rate


Grid parity - Pricing solar

1 If one makes the not-unrealistic assumption that the discounted cash flow|discount rate will be similar to

the inflation rate of grid power, then one can calculate the levelized cost

simply by dividing the original capital cost by the total amount of electricity produced over the system's lifetime.


Discounting - Other discounts

1 For 'discounts' in marketing, see discounts and allowances, sales

promotion, and pricing. The article on Discounted Cash Flow provides a

nice example about discounting and risks in real estate investments.


Financial model - Accounting

1 *Business valuation, especially discounted cash flow, but including other Valuation (finance)|valuation

problems


The Theory of Investment Value

1 thesis, which was amongst the first to articulate the theory of Discounted

Cash Flow (DCF) based valuation, and in particular, dividend based

valuation.


The Theory of Investment Value - Theory

1 While Williams did not originate the idea of present value,http://www.in-the-money.com/artandpap/I%20Present

%20Value.doc he substantiated the concept of Valuation using discounted cash flows|discounted cash flow valuation and is generally regarded as having developed the basis for

the dividend discount model (DDM).http://www.cfainstitute.org/cfaprog/university/pdf/Equi

tyPromo.pdf, http://www.finance-and-physics.org/Library/Articles3/sciencea

ndfinance/science.htm Through his approach to modelling and forecasting cash flows—which he called “algebraic

budgeting”—Williams was also a pioneer of the Pro forma#Business|pro forma modeling of financial statements.[http://roundtable.informs.org/public-access/min061a.htm]

Here, Williams (Theory, ch


The Theory of Investment Value - Theory

1 Today, “evaluation by the rule of present worth”, applied in conjunction with an Capital asset pricing

model#Asset-specific required return|asset appropriate discount rate mdash; usually derived using the capital asset pricing model of modern

portfolio theory (Harry Markowitz and William Forsyth Sharpe|William Sharpe), or the arbitrage pricing theory (Stephen Ross (economist)|Stephen Ross) mdash; is probably the most widely used stock

valuation method amongst institutional investors;http://www.investopedia.com/articles/03/011403.asp see List of finance topics#Discounted cash

flow valuation|List of valuation topics


Working capital

1 Net working capital (NWC) is calculated as current assets minus

current liabilities.[http://www.differencebetween.com/difference-between-gross-working-capital-and-vs-net-working-capital/ Gross Working Capital vs Net working Capital] It is a derivation of working capital, that is commonly

used in valuation techniques such as DCFs (Discounted cash flows)


Business valuation - Income, asset and market approaches

1 Generally, the income approaches determine value by calculating the

net present value of the benefit stream generated by the business (discounted cash flow); the asset-

based approaches determine value by adding the sum of the parts of the business (net asset value); and the market approaches determine value by comparing the subject company

to other companies in the same industry, of the same size, and/or

within the same region


Business valuation - Income approaches

1 There are several different income approaches, including capitalization of earnings or cash flows, discounted future cash flows (discounted cash flow|DCF), and the excess earnings method (which is a hybrid of asset

and income apprope of benefit stream to which it is applied)


Business valuation - Discount or capitalization rates

1 * In discounted cash flow|DCF valuations, the discount rate, often

an estimate of the cost of capital for the business is used to calculate the

net present value of a series of projected cash flows.


Business valuation - Option pricing approaches

1 Thus, for companies facing uncertainty of this type, the stock price may (should) be seen as the sum of the value of existing businesses (i.e., the discounted cash flow|discounted

cash flow value) plus any real option value.Alfred Rappaport and Michael

Mauboussin (Columbia Business School): [http://www.expectationsinvesting.com/tutorial11.shtml How Do You Assess The Value of A Company's Real Options?] Equity valuations

here, may (should) thus proceed likewise


Working capital management - Investment and project valuation

1 Harvey each project's value will be estimated using a discounted cash

flow (DCF) valuation, and the opportunity with the highest value, as measured by the resultant net

present value (NPV) will be selected (applied to Corporate Finance by Joel Dean (economist)|Joel Dean in 1951)


Working capital management - Investment and project valuation

1 The NPV is greatly affected by the

discounted cash flow|discount rate


Capital budgeting - Capital Budgeting Definition

1 Each potential project's value should be estimated using a discounted

cash flow (DCF) valuation, to find its net present value (NPV)


Capital budgeting - Capital Budgeting Definition

1 Popular methods of capital budgeting include net present value (NPV),

internal rate of return (IRR), discounted cash flow (DCF) and

payback period.


Capital budgeting - Real options

1 The discounted cash flow methods essentially value projects as if they were risky bonds, with the promised

cash flows known


Mixed-use development - Criticism

1 Another issue is that short-term discounted cash flow has become the

standard way to measure the success of income-generating

development, resulting in disposable suburban designs that make money

in the short run but are not as successful in the medium to long

term as walkable, mixed-use environments.


Real options valuation - Applicability of standard techniques

1 ROV is often contrasted with more standard techniques of capital

budgeting, such as discounted cash flow (DCF) analysis / net present

value (NPV)


Real estate appraisal - The income capitalization approach

1 Alternatively, multiple years of net operating income can be valued by a discounted cash flow analysis (DCF)

model


Yield (finance) - Real Estate Property

1 Equivalent Yield lies somewhere in between the initial yield and

reversionary yield, it encapsulates the Discounted cash flow|DCF of the property with rents rising (or falling) from the current annualised rent to

the underlying estimated rental value (ERV) less costs that are

incurred along the way. The discount rate used to calculate the net

present value (NPV) of the Discounted cash flow|DCF to equal zero is the equivalent yield, or the

Internal rate of return|IRR.


Yield (finance) - Real Estate Property

1 The calculation not only takes into account all costs, but other

assumptions including rent reviews and void periods. A trial and error

method can be used to identify the equivalent yield of a Discounted cash flow|DCF, or if using Excel, the goal

seek function can be used.


Investment analysis - Business valuation

1 There are commonly three pillars to valuing business entities:

comparable company analyses, discounted cash flow analysis, and

precedent transaction analysis


Fundamental analysis - Procedures

1 The determined growth rates (of income and cash) and risk levels (to determine the discounted cash flow|

discount rate) are used in various valuation models. The foremost is the discounted cash flow model,

which calculates the present value of the future


Discounted cash flow

1 In finance, 'discounted cash flow' ('DCF') analysis is a method of valuing a project, company, or financial asset|asset using the

concepts of the time value of money


Discounted cash flow

1 Discounted cash flow analysis is widely used in investment finance, real estate developer|real estate development, corporate financial

management and patent valuation.


Discounted cash flow - History

1 Following the stock market crash of 1929, discounted cash flow analysis

gained popularity as a valuation method for stocks


Valuation using multiples - Disadvantages

1 * Dependence on correctly valued peers: The use of multiples only

reveals patterns in relative values, not absolute values such as those

obtained from valuation using discounted cash flows|discounted cash flow valuations. If the peer group as a whole is incorrectly

valued (such as may happen during a stock market bubble) then the resulting multiples will also be

misvalued.


Valuation using multiples - Advantages

1 * Simplicity: Their very simplicity and ease of calculation makes multiples

an appealing and user-friendly method of assessing value. Multiples

can help the user avoid the potentially misleading precision of other, more ‘precise’ approaches

such as discounted cash flow valuation or EVA, which can create a

false sense of comfort.https://store.theartofservice.com/the-discounted-cash-flow-toolkit.html

Terminal value (finance)

1 It is most often used in multi-stage discounted cash flow analysis, and

allows for the limitation of cash flow projections to a several-year period


Terminal value (finance)

1 Thus, the terminal value allows for the inclusion of the value of future cash flows

occurring beyond a several-year projection period while satisfactorily mitigating many of the problems of valuing such cash flows. The

terminal value is calculated in accordance with a stream of projected future free cash flows in discounted cash flow analysis. For

whole-company Valuation (finance)|valuation purposes, there are two methodologies used

to calculate the Terminal Value.


Free cash flow - Uses of the metric

1 According to the discounted cash flow valuation model, the Intrinsic value (finance)|intrinsic value of a company is the present value of all future free cash flows, plus the cash proceeds from its eventual sale. The

presumption is that the cash flows are used to pay dividends to the shareholders. Bear in mind the

lumpiness discussed below.https://store.theartofservice.com/the-discounted-cash-flow-toolkit.html

Residual income valuation - Concept

1 It is thus possible that a value deemed positive using a traditional

discounted cash flow (DCF) approach may be negative here


Residual income valuation - Comparison with other valuation methods

1 As can be seen, the residual income valuation formula is similar to the

dividend discount model (DDM) (and to other discounted cash flow (DCF)

valuation models), substituting future residual earnings for dividend (or free

cash) payments (and the cost of equity for the weighted average cost

of capital).


Adjusted present value

1 Technically, an APV valuation model looks similar to a standard

Discounted cash flow|DCF model. However, instead of weighted

average cost of capital|WACC, cash flows would be discounted at the unlevered cost of equity, and tax shields at either the cost of debt

(Myers) or following later academics also with the unlevered cost of

equity.http://www.iese.edu/research/pdfs/DI-0488-E.pdf


Intrinsic value (finance) - Options

1 :IV_ \mathrm out-of-the-moneySee also|Valuation using discounted cash

flows|John Burr Williams#Theory


Intrinsic value (finance) - Options

1 In valuing Stock|equity, securities analysts may use fundamental analysis—as opposed

to technical analysis—to estimate the intrinsic value of a company. Here the

intrinsic characteristic considered is the expected cash flow production of the

company in question. Intrinsic value is therefore defined to be the present value of

all expected future net cash flows to the company; it is calculated via discounted cash

flow valuation.


Pensions crisis - U.S. State-level issues

1 *, the state pension shortfall ranges between $700 billion and $3 trillion,

depending on the discounted cash flow|discount rate used to value the future

obligations. The $700 billion figure is based on using a discount rate in the 8% range representative of historical pension fund investment returns, while the $3 trillion

represents a discount rate in the 5% range representative of historical Treasury bond

(risk-free) yields.https://store.theartofservice.com/the-discounted-cash-flow-toolkit.html

Actuarial - History

1 For example, one traditional actuarial method suggests that changing the asset allocation mix of investments can change the value of liabilities

and assets (by changing the discounted cash flow|discount rate

assumption)


Income approach

1 While there are quite a few acceptable methods under the rubric

of the income approach, most of these methods fall into three

categories: direct capitalization, discounted cash flow, and gross

income multiplier.


Income approach - Direct Capitalization

1 If either cash flows or risk levels are expected to change, then direct

capitalization fails and a discounted cash flow method must be used.


Income approach - Discounted Cash Flow

1 The Discounted cash flow model is analogous to net present value estimation in finance


P/E ratio - Interpretation

1 Using discounted cash flow analysis, the impact of earnings growth and inflation can be evaluated. Using

constant historical earnings growth rate of 3.8 and post-war SP 500

returns of 11% (including 4% inflation) as the discount rate, the

fair P/E is obtained as 14.42. A stock growing at 10% for next five years

would have a fair P/E of 18.65.https://store.theartofservice.com/the-discounted-cash-flow-toolkit.html

Value investing - Further evolution

1 One modern model of calculating value is the discounted cash flow

model (DCF), where the value of an asset is the sum of its future cash

flows, discounted back to the present.


Copenhagen Consensus - Results

1 Kåre Fog further pointed out that the future benefits of emissions

reduction were Discounted Cash Flow|discounted at a higher rate than

for any of the other 27 proposals,http://www.lomborg-

errors.dk/CopCons2008.htm stating so there is an obvious reason why the climate issue always is ranked last in Lomborg's environmental

studies.https://store.theartofservice.com/the-discounted-cash-flow-toolkit.html

Debt cash flow

1 'Debt Cash Flow' is a finance term describing a firm's non-Equity cash

flows. Theoretically, adding the discounted Debt Cash Flow to the discounted Flows to equity (also

known as Equity Cash Flows) will give the firm's enterprise value. The Enterprise value is the valuation

obtained by calculating the Discounted Cash Flow (also DCF).


Debt cash flow

1 The term Debt Cash Flow is not in common usage; hence it is likely that when the acronym DCF is used the meaning is Discounted cash flow.


Stochastic modeling - Means

1 For example, in application, applying the best estimate (defined as the mean) of investment returns to

discount a set of cash flows will not necessarily give the same result as assessing the best estimate to the

discounted cash flows.


Bond valuation

1 Hence, the value of a bond is obtained by discounting the bond's expected cash flows to the present

using an appropriate discounted cash flow|discount rate


Economics of climate change mitigation - Discount rates

1 Discounting can either be prescriptive or descriptive. The descriptive approach is

based on what discount rates are observed in the behaviour of people making every

day decisions (the private discounted cash flow|discount rate) (IPCC, 2007c:813). In

the prescriptive approach, a discount rate is chosen based on what is thought to be in

the best interests of future generations (the social discount rate).


Earnings growth - Overview

1 Earnings growth rate is a key value that is needed when the Discounted

cash flow|DCF model, or the Gordon's model is used for stock valuation.


Earnings growth - On-line valuation calculators

1 *[http://www.moneychimp.com/articles/valuation/dcf.htm

http://www.moneychimp.com/articles/valuation/dcf.htm]: Discounted Cash Flows Calculator that assumes that a higher growth can be sustained for a

limited number of years.


International Valuation Standards Committee - Technical Information Papers (TIPs)

1 There are currently three finalized TIPs on Discounted Cash Flows, The Cost Approach for Tangible Assets

and The Valuation of Intangible Assets. The Standards Board are currently working on additional

papers[http://ivsc.org/library List of Drafts].


RNPV

1 In finance, 'rNPV' (risk-adjusted net present value) or 'eNPV' (expected

NPV) is a method to value risky future cash flows. rNPV modifies the

standard NPV calculation of discounted cash flow (DCF) analysis by adjusting (multiplying) each cash

flow by the estimated probability that it occurs (the estimated success

rate). In the language of probability theory, the rNPV is the expected

value.


Minimum acceptable rate of return

1 A common method for evaluating a hurdle rate is to apply the discounted

cash flow method to the project, which is used in net present value

models


Share price - History

1 Following this, the next stage was the use of discounted cash flows,

based on the time value of money, to estimate the intrinsic value of stock.


Mortgage yield

1 In finance, 'mortgage yield' is a measure of yield (finance)|yield of Mortgage-backed

security|mortgage-backed bonds. It is also known as cash flow yield. The mortgage yield,

or cash flow yield, of a mortgage-backed bond is the monthly compounded discounted cash flow|discount rate at which net present value of all

future cash flows from the bond will be equal to the present price of the bond.Choudhry,

Moorad. Capital Market Instruments: Analysis and Valuation, (FT Press, 2002), p. 208.


Discount rate

1 * in investment financing, discounted cash flow


Discount rate

1 ** in environmental economics, and more generally in assessing the

general welfare impacts of government policies, social discount rate (the basic mathematics is the same as discounted cash flow, but the cash value of human lives etc.

can only be crudely estimated)


Sustainable growth rate - Sustainable growth rates (SGR) from a financial perspective

1 The sustainable growth rate model has implications for valuation

models, as for instance the Gordon model and other discounted cash

flow models require a growth estimate that can be sustained for

many years. The sustainable growth rate can be a check if business plans

are reasonable.


NOPLAT

1 'Net operating profit less adjusted taxes' ('NOPLAT') refers to total operating profits for a firm with adjustments made for taxes. It

represents the profits generated from a company's core operations after

subtracting the income taxes related to the core operations. NOPLAT is often used as an input in creating valuation using discounted cash

flows|discounted cash flow valuation models.


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