Discounting cash flows calculation formula and examples. Evaluation of investment projects using discounted cash flows Discounted cash flow shows

Decide on the discount rate to use. It can be determined using the capital asset pricing model (CAPM) formula: risk-free rate of return + sensitivity of the asset to changes in market returns * (the risk premium for investing in medium-risk investments). For stocks, the risk premium is around 5%. Since the stock market prices most stocks over a period of 10 years, the risk-free rate of return on them will be equal to the yield on a ten-year Treasury bond. For the purposes of this article, let's assume that it is 2%. So, with a sensitivity of 0.86 (meaning 86% exposure to market fluctuations for medium-risk investments in the overall market), the discount rate for stocks would be 2% + 0.86*(5%) = 6.3%.

Determine the type of cash flows to discount.

simple cash flow is a single receipt of funds in the future, for example, receiving $ 1,000 in ten years.
Annuity cash flows are constant cash receipts at fixed intervals over a specified period, such as receiving $1,000 annually for 10 years.
Growing annuity cash flows are expected to grow at a constant rate over a certain period of time. For example, for 10 years, an amount of $ 1,000 will be received, increasing every year by 3%.
perpetuities(perpetual annuities) - continuous, never-ending cash flows at regular intervals, such as a $1,000 annual preferred stock dividend.
Growing Perpetuities- these are constant non-ending receipts of funds at regular intervals, which, according to expectations, will grow at a constant rate. For example, a stock dividend of $2.2 in the current year followed by an annual increase of 4%.

To calculate the discounted cash flow, use the appropriate formula:

For simple cash flow: present value = future cash receipts/(1 + discount rate)^time period. For example, the present value of $1,000 received in 10 years at a discount rate of 6.3% would be $1,000/(1 + 0.065)^10 = $532.73.
For annuities: present value = annual cash flows*(1-1/(1+discount rate)^number of periods)/discount rate. For example, the present value of $1000 received annually for 10 years at a discount rate of 6.3% would be $1000*(1-1/(1+0.063)^10)/0.063 = $7256.60.
For growing annuities: present value = cash flow*(1+g)*(1-(1+g)^n/(1+r)^n)/(rg) where r = discount rate, g = cash flow growth factor, n = number of periods. For example, the present value of $1,000 flows with a 3% annual increase over 10 years at a discount rate of 6.3% would be $1,000*(1+0.03)*(1-(1+0.03)^10/( 1+0.063)^10)/(0.063-0.03) = $8442.13.
For perpetuities: present value = cash flows/discount rate. For example, the present value of a $1,000 regular preferred stock dividend at a discount rate of 6.3% would be $1,000/0.063 = $15,873.02.
For growing perpetuities: present value = expected cash flow next year/(discount rate - expected growth rate). For example, the present value of a $2.2 share dividend that is expected to rise 4% next year, at a discount rate of 6.3% would be $2.20*(1.04)/(0.063-0, 04) = $99.48.

Discounting from the English "discounting" - bringing economic values for different periods of time to a given period of time.

If you do not have an economic or financial education behind you, then this term is most likely not familiar to you and this definition is unlikely to explain the essence of “discounting”, rather, it will confuse you even more.

However, it makes sense for a prudent owner of his budget to understand this issue, since each person finds himself in a situation of “discounting” much more often than it seems at first glance.

Discounting - information from Wikipedia

Description of discounting in simple words

What Russian is not familiar with the phrase "know the value of money"? This phrase comes to mind as soon as the line at the checkout approaches, and the buyer takes another look at his grocery cart to remove the “unnecessary” product from it. Still, in our time we have to be prudent and economical.

Discounting is often understood as an economic indicator that determines the purchasing power of money, their value over a certain period of time. Discounting allows you to calculate the amount that you need to invest today in order to receive the expected return some time later.

Discounting as a tool for predicting future profits is in demand among business representatives at the stage of planning the results (profit) from investment projects. Future results may be announced at the beginning of the project or during the implementation of its subsequent stages. To do this, the given indicators are multiplied by the discount factor.

Discounting also "works" in the interests of the average person, not connected to the world of big investments.

For example, all parents strive to give their child a good education, and, as you know, it can cost a lot of money. Not everyone has financial resources (cash reserve) at the time of admission, so many parents think about a “stash” (a certain amount of money spent past the family budget cash desk), which can help out at X hour.

Let's say that in five years your child will graduate from school and decide to enter a prestigious European university. Preparatory courses at this university cost $2,500. You are not sure that you can carve out this money from the family budget without prejudice to the interests of all family members. There is a way out - you need to open a deposit in a bank, for this it would be good to first calculate the amount of the deposit that you must open in the bank now, so that at the X-hour (that is, five years later) you will receive 2500, provided that the maximum favorable interest that can offer the bank, say -10%. To determine how much future spending (cash flow) is worth today, we make a simple calculation: Divide $2500 by (1.10)2 to get $2066. This is what discounting is.

Simply put, if you want to know what the value of the amount of money you will receive or intend to spend in the future, then you should "discount" this future amount (income) at the rate of interest offered by the bank. This rate is also called the "discount rate".

In our example, the discount rate is 10%, $2,500 is the amount of the payment (or cash outflow) after 5 years, and $2,066 is the discounted value of the future cash flow.

Discount formulas

All over the world it is customary to use special English terms to denote the current (discounted) and future value: future value (FV) And present value (PV). It turns out that $ 2,500 is FV, that is, the value of money in the future, and $ 2,066 is PV, that is, the value at this point in time.

The formula for calculating the present value for our example looks like this: 2500 * 1/(1+R)n = 2066.

General discount formula: PV = FV * 1/(1+R)n

Factor by which the future value is multiplied 1/(1+R)n, is called the "discount factor",
R- interest rate
N is the number of years from a date in the future to the present.

As you can see, these mathematical calculations are not so difficult and not only bankers can do it. In principle, you can give up on all these figures and calculations, the main thing is to capture the essence of the process.

Discounting is the path of cash flow from the future to today - that is, we go from the amount we want to receive after a certain amount of time to the amount that we must spend (invest) today.

Life formula: time + money

Let's imagine another situation familiar to everyone: you have "free" money, and you went to the bank to make a deposit of, say, $2,000. Today, $2,000 deposited in the bank at a bank rate of 10% will cost $2,200 tomorrow, that is, $2,000 + interest on the deposit 200 (=2000*10%) . It turns out that in a year you will be able to receive 2200 dollars.

If we represent this result in the form of a mathematical formula, then we have: $2000*(1+10%) or $2000*(1,10) = $2200 .

If you deposit $2,000 for a period of two years, that amount will convert to $2,420. We consider: $2000 + interest for the first year $200 + interest for the second year $220 = 2200*10% .

The general formula for increasing the contribution (without additional contributions) for two years looks like this: (2000*1,10)*1,10 = 2420

If you want to extend the term of the deposit, your income on the deposit will increase even more. To find out the amount that the bank will pay you in a year, two or, say, five years, you need to multiply the deposit amount with a multiplier: (1+R)N.

Wherein:

R is the interest rate expressed as fractions of a unit (10% = 0.1),
N indicates the number of years.

Discounting and accrual operations

Thus, it is possible to determine the value of the contribution at any time point in the future.

Calculating the future value of money is called "accrual".

The essence of this process can be explained by the example of the well-known expression “time is money”, that is, over time, the monetary contribution grows due to the increment of annual interest. The whole modern banking system works on this principle, where time is money.

When we discount, we move from the future to today, and when we “increase”, the trajectory of money movement is directed from today to the future.

Both "calculation chains" (both discounting and building up) make it possible to analyze possible changes in the value of money over time.

Discounted Cash Flow Method (DCF)

We have already mentioned that discounting - as a tool for predicting future profits - is necessary to calculate the project's performance assessment.

So, when assessing the market value of a business, it is customary to take into account only that part of the capital that is capable of generating income in the future. At the same time, many points are important for the business owner, for example, the time of receipt of income (monthly, quarterly, at the end of the year, etc.); what risks may arise in connection with profitability, etc. These and other features that affect the valuation of a business are taken into account by the DCF method.

Discount coefficient

The method of discounting cash flows is based on the law of the "falling" value of money. This means that over time, money "cheapens", that is, it loses its value compared to its current value.

It follows from this that it is necessary to build on the assessment at the current moment, and correlate all subsequent cash flows or outflows with today. This will require a discount factor (Kd), which is needed to convert future earnings to present value by multiplying Kd by the cash flows. The calculation formula looks like this:

where: r- discount rate, i– time period number.

DCF calculation formula

The discount rate is the main component of the DCF formula. It shows what size (rate) of profit a business partner can expect when investing in a project. The discount rate takes into account various factors, depending on the object of assessment, and may include: the inflation component, the assessment of capital shares, the return on risk-free assets, the refinancing rate, interest on bank deposits, and more.

It is generally accepted that a potential investor will not invest in a project whose value will be higher than the present value of the future income from the project. Likewise, an owner would not sell his business for a price that is less than the estimated value of future earnings. As a result of the negotiations, the parties will agree on a market price, which is equivalent to the current value of the projected income.

The ideal situation for an investor is when the internal rate of return (discount rate) of the project is higher than the costs associated with finding funding for the business idea. In this case, the investor will be able to “earn” the way banks do, that is, accumulate money at a reduced interest rate, and invest it in a project at a higher rate.

Discounting and investment projects

The discounted cash flow method is in line with the investment motives of the business.

This means that an investor who invests in a project does not acquire technical or human resources in the form of a team of highly qualified specialists, modern offices, warehouses, high-tech equipment, etc., but the future flow of money. If we continue this thought, it turns out that any business “releases” the only product on the market - this is money.

The main advantage of the discounted cash flow method is that this valuation method, the only one of all existing ones, is focused on the future development of the market, which contributes to the development of the investment process.

In the article we will talk in detail about discounting cash flows, the calculation and analysis formula in Excel.

Discounting cash flows. Definition

Cash flow discounting (English Discounted cash flow, DCF, discounted value) is the reduction of the value of future (expected) cash payments to the current moment in time. Discounting cash flows is based on the important economic law of diminishing value of money. In other words, over time, money loses its value compared to the current one, so it is necessary to take the current moment of assessment as a starting point and bring all future cash receipts (profits / losses) to the present. For this purpose, a discount factor is used.

How to calculate the discount factor?

Discount coefficient is used to convert future earnings to present value by multiplying the discount factor and the cash flows. The formula for calculating the discount factor is shown below:

where: r is the discount rate, i is the number of the time period.

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Discounting cash flows. Calculation formula

DCF( discounted cash flow– discounted cash flow;

CF ( Cashflow) - cash flow in time period I;

r is the discount rate (rate of return);

n is the number of time periods for which cash flows appear.

The key element in the discounted cash flow formula is the discount rate. The discount rate shows what rate of return an investor should expect when investing in a particular investment project. The discount rate uses many factors that depend on the object of assessment, and may include: inflation component, return on risk-free assets, additional rate of return for risk, refinancing rate, weighted average cost of capital, interest on bank deposits, etc.

Calculating the rate of return (r) for discounting cash flows

There are many different ways and methods for estimating the discount rate (rate of return) in investment analysis. Let us consider in more detail the advantages and disadvantages of some methods for calculating the rate of return. This analysis is presented in the table below.

Methods for estimating the discount rate	Advantages	disadvantages
CAPM Models	Ability to account for market risk	One-factor, the need for the presence of ordinary shares in the stock market
Gordon Model	Ease of calculation	The need for ordinary shares and constant dividend payments
Weighted average cost of capital (WACC) model	Accounting for the rate of return of both equity and debt capital	Difficulty in assessing return on equity
Model ROA, ROE, ROCE, ROACE	Ability to take into account the return on capital of the project	Not taking into account additional macro, micro risk factors
E/P method	Accounting for the market risk of the project	Availability of quotes on the stock market
Method for estimating risk premiums	Using Additional Risk Criteria in Estimating the Discount Rate	Subjectivity of risk premium estimation
Judgment-Based Appraisal Method	Possibility to take into account weakly formalized project risk factors	Subjectivity of expert assessment

You can learn more about the approaches to calculating the discount rate in the article "".

★
(calculation of Sharpe, Sortino, Trainor, Kalmar, Modiglanchi beta, VaR ratios)
+ rate movement forecasting

Example of calculating discounted cash flow in Excel

In order to calculate discounted cash flows, it is necessary for the selected time period (in our case, annual intervals) to describe in detail all the expected positive and negative cash payments (CI - Cashinflow, CO CashOutflow). The following payments are taken for cash flows in valuation practice:

Net operating income;
Net cash flow excluding operating costs, land tax and facility refurbishment;
Taxable income.

In domestic practice, as a rule, a period of 3-5 years is used; in foreign practice, the assessment period is 5-10 years. The entered data is the basis for further calculation. The figure below shows an example of entering initial data in Excel.

The next step is to calculate the cash flow for each of the time periods (column D). One of the key tasks in assessing cash flows is to calculate the discount rate, in our case it is 25%. And was obtained by the following formula:

Discount rate= Risk free rate + Risk premium

The key rate of the Central Bank of the Russian Federation was taken as the risk-free rate. The key rate of the Central Bank of the Russian Federation is currently 15% and the premium for risks (production, technological, innovative, etc.) was calculated by an expert at the level of 10%. The key rate reflects the return on a risk-free asset, and the risk premium shows an additional rate of return on the existing risks of the project.

You can learn more about calculating the risk-free rate in the following article: ""

After that, it is necessary to bring the received cash flows to the initial period, that is, multiply them by the discount factor. As a result, the sum of all discounted cash flows will give the present value of the investment object. The calculation formulas will be as follows:

Cash flow (CF)=B6-C6

Discounted cash flow (DCF)= D6/(1+$C$3)^A6

Total discounted cash flow (DCF)= SUM(E6:E14)

As a result of the calculation, we received the discounted value of all cash flows (DCF) equal to 150,981 rubles. This cash flow has a positive value, which indicates the possibility of further analysis. When conducting an investment analysis, it is necessary to compare the final values of the discounted cash flow for various alternative projects, this will allow them to be ranked according to the degree of attractiveness and efficiency in creating value.

Investment analysis methods using discounted cash flows

It should be noted that discounted cash flow (DCF) in its calculation formula is very similar to net present value (NPV). The main difference lies in the inclusion of initial investment costs in the NPV formula.

Discounted cash flow (DCF) is used in many methods for evaluating the effectiveness of investment projects. Due to the fact that these methods use discounted cash flows, they are called dynamic.

Dynamic methods for evaluating investment projects
- Net present value (NPV,Netpresentvalue)
- Internal rate of return ( IRR, Internal Rate of Return)
- profitability index (PI, Profitability index)
- Annuity equivalent (NUS, Net Uniform Series)
- net rate of return ( NRR, Net Rate of Return)
- Net future value ( nfv,NetFuturevalue)
- Discounted payback period (DPP,Discountedpayback period)

You can learn more about the methods for calculating the effectiveness of investment projects in the article "".

Besides only discounting cash flows, there are more sophisticated methods that additionally take into account the reinvestment of cash payments.

Modified net rate of return ( MNPV, Modified Net Rate of Return)
Modified rate of return ( MIRR, Modified Internal Rate of Return)
Modified net present value ( MNPV,modifiedpresentvalue)

★
(calculation of Sharpe, Sortino, Trainor, Kalmar, Modiglanchi beta, VaR ratios)
+ rate movement forecasting

Advantages and Disadvantages of the DCF Measure of Discounted Cash Flows

+) The use of the discount rate is an undoubted advantage of this method, as it allows you to bring future payments to the current value and take into account possible risk factors when assessing the investment attractiveness of the project.

-) The disadvantages include the difficulty of predicting future cash flows for an investment project. In addition, it is difficult to reflect changes in the external environment in the discount rate.

Summary

Cash flow discounting is the basis for calculating many coefficients for evaluating the investment attractiveness of a project. We analyzed the example of the algorithm for calculating discounted cash flows in Excel, their existing advantages and disadvantages. Ivan Zhdanov was with you, thank you for your attention.

Do you know what discounting means? If you are reading this article, then you have already heard this word. And if you have not yet fully understood what it is, then this article is for you. Even if you are not going to take the Dipifre exam, but just want to understand this issue, after reading this article, you can clarify for yourself the concept of discounting.

This article explains in plain language what is discounting. Using simple examples, it shows the technique for calculating the present value. You will learn what a discount factor is and how to use it

The concept and formula of discounting in plain language

To make it easier to explain the concept of discounting, let's start from the other end. To be more precise, let's take an example from life, familiar to everyone.

Example 1 Imagine you walk into a bank and decide to deposit $1,000. Your $1,000 deposited in the bank today, at a bank rate of 10%, will be worth $1,100 tomorrow: $1,000 today + deposit interest 100 (=1000*10%). In total, in a year you will be able to withdraw $1,100. If we express this result through a simple mathematical formula, we get: $1000*(1+10%) or $1000*(1.10) = $1100.

In two years, the current $1,000 will be $1,210 ($1,000 plus first year interest $100 plus second year interest $110=1100*10%). The general formula for the increment of the contribution for two years: (1000 * 1.10) * 1.10 \u003d 1210

Over time, the value of the contribution will continue to grow. To find out how much you are due from the bank in a year, two, etc., you need to multiply the amount of the deposit by the multiplier: (1 + R) n

where R is the interest rate expressed as fractions of a unit (10% = 0.1)
N - number of years

In this example, 1000*(1.10) 2 = 1210. From the formula it is obvious (and from life too) that the deposit amount after two years depends on the bank interest rate. The larger it is, the faster the contribution grows. If the bank interest rate were different, for example, 12%, then in two years you would be able to withdraw approximately $ 1250 from the deposit, and if you calculate more precisely 1000 * (1.12) 2 = 1254.4

In this way, you can calculate the value of your contribution at any time in the future. The calculation of the future value of money in English is called "compounding". This term is translated into Russian as "building" or tracing paper from English as "compounding". Personally, I prefer the translation of this word as “increment” or “growth”.

The meaning is clear - over time, the monetary contribution increases due to the increment (increase) in annual interest. On this, in fact, the entire banking system of the modern (capitalist) model of the world order is built, in which time is money.

Now let's look at this example from the other end. Let's say you need to repay a debt to your friend, namely: in two years to pay him $1210. Instead, you can give him $1,000 today, and your friend will put that amount in the bank at a 10% annual rate, and in two years, withdraw exactly the required amount of $1,210 from the bank deposit. That is, these two cash flows: $1000 today and $1210 in two years - are equivalent each other. It doesn't matter what your friend chooses - these are two equal possibilities.

EXAMPLE 2. Let's say in two years you need to make a payment in the amount of $1,500. What will this amount be equivalent to today?

To calculate today's value, you need to work backwards: $1,500 divided by (1.10) 2 equals about $1,240. This process is called discounting.

In simple terms, then discounting is determining the present value of a future amount of money (or more correctly, future cash flow).

If you want to find out how much money you either receive or plan to spend in the future is worth today, you need to discount that future amount at a given interest rate. This rate is called "discount rate". In the last example, the discount rate is 10%, $1,500 is the amount of the payment (cash outflow) after 2 years, and $1,240 is the so-called discounted value future cash flow. In English, there are special terms for today's (discounted) and future value: future value (FV) and present value (PV). In the example above, $1500 is the future value of FV and $1240 is the present value of PV.

When we discount, we move from the future to today.

Discounting

When we build up, we go from today into the future.

Accretion

The formula for calculating the present value or the discounting formula for this example is: 1500 * 1/(1+R) n = 1240.

Mathematical in the general case will be as follows: FV * 1/(1+R) n = PV. It is usually written in this form:

PV = FV * 1/(1+R)n

Factor by which the future value is multiplied 1/(1+R)n is called the discount factor from the English word factor in the meaning of "coefficient, multiplier".

In this discounting formula: R is the interest rate, N is the number of years from a date in the future to the current moment.

In this way:

Compounding or Increment is when you go from today's date to the future.
Discounting or Discounting is when you go from the future to today.

Both "procedures" take into account the effect of changes in the value of money over time.

Of course, all these mathematical formulas immediately make an ordinary person sad, but the main thing is to remember the essence. Discounting is when you want to know the present value of a future amount of money (which you will have to spend or receive).

I hope that now, having heard the phrase "the concept of discounting", you will be able to explain to anyone what is meant by this term.

Is present value a discounted value?

In the previous section, we found out that

Discounting is the determination of the present value of future cash flows.

Isn't it true that in the word "discounting" one hears the word "discount" or in Russian a discount? Indeed, if you look at the etymology of the word discount, then already in the 17th century it was used in the meaning of “deduction for early payment”, which means “discount for early payment”. Even then, many years ago, people took into account the time value of money. Thus, one more definition can be given: discounting is the calculation of a discount for paying bills quickly. This "discount" is a measure of the time value of money or time value of money.

The discounted value is the present value of the future cash flow (i.e. the future payment minus the "discount" for fast payment). It is also called the present value, from the verb "to bring". In simple words, present value is future amount of money reduced to the current moment.

To be precise, discounted value and present value are not absolute synonyms. Because you can bring not only the future value to the current moment, but also the current value to some point in the future. For example, in the very first example, we can say that $1,000 adjusted to the future (two years from now) at a rate of 10% equals $1,210. That is, I want to say that the present value is a broader concept than the present value.

By the way, there is no such term (present value) in English. This is our purely Russian invention. In English, there is the term present value (current value) and discounted cash flows (discounted cash flows). And we have the term present value, and it is most often used in the meaning of "discounted" value.

Discount table

A little higher I already cited discount formula PV = FV * 1/(1+R) n, which can be described as:

The present value is equal to the future value multiplied by a factor called the discount factor.

The discount factor 1/(1+R) n , as can be seen from the formula itself, depends on the interest rate and the number of time periods. In order not to calculate it every time according to the discounting formula, they use a table showing the coefficient values depending on the% rate and the number of time periods. Sometimes it is called a "discount table", although this is not quite the correct term. This discount factor table, which are calculated, as a rule, with an accuracy of four decimal places.

Using this table of discount coefficients is very simple: if you know the discount rate and the number of periods, for example, 10% and 5 years, then the coefficient you need is located at the intersection of the corresponding columns.

Example 3 Let's take a simple example. Let's say you have to choose between two options:

A) get $100,000 today
B) or $150,000 in one lump sum in exactly 5 years

What to choose?

If you know that the bank rate on 5-year deposits is 10%, then you can easily calculate what the amount of $150,000 receivable in 5 years equals to the current moment.

The corresponding discount factor in the table is 0.6209 (cell at the intersection of row 5 years and column 10%). 0.6209 means that 62.09 cents received today equals $1 due in 5 years (at a rate of 10%). Simple proportion:

So $150,000*0.6209 = 93.135.

93,135 is the discounted (present) value of $150,000 receivable in 5 years.

It's less than $100,000 today. In this case, a tit in the hands is really better than a pie in the sky. If we take 100,000 dollars today, put them on a bank deposit at 10% per annum, then after 5 years we will get: 100,000*1.10*1.10*1.10*1.10*1.10 = 100,000*( 1.10) 5 = $161,050. This is a more profitable option.

To simplify this calculation (calculating the future value given today's value), you can also use the ratio table. By analogy with the discount table, this table can be called a table of increment (increment) coefficients. You can build such a table yourself in Excel if you use the formula to calculate the increment factor: (1+R)n.

This table shows that $1 today at 10% will be worth $1.6105 in 5 years.

Using such a table, it will be easy to calculate how much money you need to put in the bank today if you want to receive a certain amount in the future (without replenishing the deposit). A slightly more complicated situation arises when you not only want to deposit money today, but also intend to add a certain amount to your contribution every year. How to calculate this, read the following article. It is called annuity formula.

A philosophical digression for those who have read this far

Discounting is based on the famous postulate "time is money". If you think about it, this illustration has a very deep meaning. Plant an apple tree today and in a few years your apple tree will grow and you will be picking apples for years. And if today you do not plant an apple tree, then in the future you will not try apples.

All we need is to decide: plant a tree, start our own business, take the path that leads to the fulfillment of a dream. The sooner we begin to act, the greater the harvest we will receive at the end of the journey. We need to turn the time allotted to us in our lives into results.

"The seeds of flowers that bloom tomorrow are planted today." That's what the Chinese say.

If you dream of something, do not listen to those who discourage you or question your future success. Don't wait for luck, start as early as possible. Turn the time of your life into results.

Large table of discount factors (opens in a new window):

Investing means investing free financial resources today in order to obtain stable cash flows in the future. How not to make a mistake and not only return the invested funds, but also make a profit from investments?

This article provides not only the formula and definition of IRR, but there are examples of calculating this indicator (in Excel, graphical) and interpreting the results. Two examples from life that every person faces

At its core, the discount rate in the analysis of investment projects is the interest rate at which the investor attracts financing. How to calculate it?

Discounted cash flow represents the financial flows associated with various projects and adjusted for how they are distributed over time and potential interest on invested funds. Here it is very important to take into account the time aspect, since most investment projects are characterized by the fact that the main costs or outflows of funds occur in the first years, and the income from them, that is, cash inflows, will be distributed for many years to come.

Economic importance

The cost of the company's operation depends on the main factors, which are the value of assets on the market, as well as the amount of income that is obtained as a result of the effective implementation of activities at the current time. The goal of potential investors is to receive a very specific profit from their capital. Therefore, the profitability of the functioning of the organization is a very important point not only for owners, but also for investors, which is why it is taken into account during the implementation of appraisal work in order to determine the value of the business.

The discounted cash flow method has become one of the most commonly used in assessing these characteristics. This approach is relevant due to the fact that the process of cash flow management for all parties is of incredible importance: it can be used to manage the value of the business, increasing the financial flexibility of the company itself. Discounted cash flow is able to compare income and expenses, taking into account depreciation and depreciation, receivables, capital investments, changes in the structure of working capital of the company itself. That is why many people use this method for calculations.

How to use?

Empirical data have shown that discounted cash flow is somewhat dependent on the value of the enterprise in the market, but profits in the accounting sense do not correlate well with market value, because the former cannot always serve as a determining factor in the value of the enterprise.

When using this method, the cost is calculated in a certain way. The analysis and forecasting of gross income, investments and expenses, the calculation of financial flows for each reporting year, the discount rates are calculated, and then the available cash flows are discounted, the residual value is calculated. After all this, it is required to sum the present values of future cash flows with the residual value, adjust and verify the results.

Various calculation options

The discounted cash flow method allows you to use two types to calculate the value of an enterprise: equity and investment capital. If we are talking about equity, then the most important indicator is the degree of value of the data obtained for the company's manager, since the company's need to raise funds is taken into account. In practice, debt-free cash flow is used by investors to finance mergers, acquisitions or acquisitions of a company by raising new funds from borrowers.

The discounted cash flow for the firm's capital is calculated in a special way. Depreciation and changes in long-term debt are added to net profit for a certain period, and capital investments for the period and an increase in the working capital of the company are subtracted from the amount received. It is important to understand that cash flows are forecast for the next 5 years. The probability that there will be certain deviations from the forecast is high, so a whole range of forecasts is made: optimistic, pessimistic and most probable. For each, the weighted average yield is calculated and a specific weight is put down. Cash flow for equity and debt can be nominal or real. The discounted value of the cash flow is determined at the end or middle of the year. In the latter case, the result will be more accurate, so it is preferable.

Discount rate

In the process of determining the discount rate, it is necessary to understand that it is considered as the lower limit level of profitability of investments sufficient for the investor to see the feasibility of investing his funds in the company, especially when taking into account the availability of alternative investments that involve income from a certain degree of risk. Risk here refers to the possibility of expectations not meeting the actual results, as well as the loss of property due to the bankruptcy of the enterprise, economic or political factors, as well as events of a different nature.

What to do next?

When the discounted net cash flow is calculated, the amount of business income that will occur in the post-forecast period should be identified. The calculation is based on the fact that the residual value is the present value of the cash flow obtained after a discrete forecast period. It includes the value of all financial flows in all periods that remained outside the scope of one forecast year. The calculation of the residual value can be done using one of the methods.

The net asset value method requires the book value at the end of the period to be used as the residual value. For a profitable enterprise, the use of such a method is inappropriate.

To evaluate by liquid value, it is required to calculate its indicator for assets at the end of the forecasting period. There is a set of factors influencing the liquid value. Here we can distinguish low attractiveness due to inappropriate appearance, industry factors and territorial location.

conclusions

For the completeness of the valuation for the operating enterprise, you can use both discounted cash flow and market or cost. With this, you can avoid some degree of subjectivity, making the valuation of the business as accurate as possible.