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

  1. Estimate future cash flows: project cash flows for each year.
  2. Choose a discount rate: typically the WACC (weighted average cost of capital), often 8-12%.
  3. 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