Topic 21
Discounted Cash Flow: An Introduction
Topic 21 presents the mechanics of the discounted cash flow (DCF) valuation process and how it is done. The DCF process is more data intensive than the valuation methods discussed in Topic 20. The flexibility of modeling and valuing the possible economic profiles of a business forecast generally outweigh the data intensity and time required to prepare meaningful DCF valuations.
The reader is encouraged to take the time to read the text in conjunction with the referenced Appendices to gain the appropriate level of understanding of the subject matter discussed in the narrative. Appendices are either presented at the end of this Topic or are available for review and download on the companion Web site noted at the end of this Topic.
DCF—INTRODUCTION, ADVANTAGE, DISADVANTAGE
- The discounted cash flow valuation process yields identical results to the capitalization or perpetuity value methods illustrated in Topic 20, where the returns (R) and growth (g) are constant and the life is perpetual.
- The advantage of DCF versus capitalization is that value can be derived from uneven future periodic flows and uneven growth rates for any number of future periods (n).
- The disadvantage is that it is more computationally intensive.
- The discounting process is the exact opposite of the compounding process.1
COMPOUNDING
- In compounding, a future value is determined by multiplying an amount times 1 plus a constant compounding factor, then multiplying that ...
