Jason fernando
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Discounted Cash Flow
If we sum up all of the discounted cash flows, we get a value of $13,306,728. Subtracting the initial investment of $11 million, we get a net present value (NPV) of $2,306,728. Because this is a positive number, the cost of the investment today is worth it as the project will generate positive discounted cash flows above the initial cost. If the project had cost $14 million, the NPV would have been -$693,272, indicating that the cost of the investment would not be worth it.
Dividend discount models, such as the Gordon Growth Model (GGM), for valuing stocks are examples of using discounted cash flows. Disadvantages of Discounted Cash Flow The main limitation of DCF is that it requires making many assumptions. For one, an investor would have to correctly estimate the future cash flows from an investment or project. The future cash flows would rely on a variety of factors, such as market demand, the status of the economy, unforeseen obstacles, and more. Estimating future cash flows too high could result in choosing an investment that might not pay off in the future, hurting profits. Estimating cash flows too low, making an investment appear costly, could result in missed opportunities. Choosing a discount rate for the model is also an assumption and would have to be estimated correctly for the model to be worthwhile. Frequently Asked Questions How do you calculate discounted cash flow (DCF)? Calculating the DCF of an investment involves three basic steps. First, you forecast the expected cashflows from the investment. Second, you select a discount rate, typically based on the cost of financing the investment or the opportunity cost presented by alternative investments. The third and final step is to discount the forecasted cashflows back to the present day, using a financial calculator, a spreadsheet, or a manual calculation. What is an example of a DCF calculation? To illustrate, suppose you have a discount rate of 10% and an investment opportunity that would produce $100 per year for the following three years. Your goal is to calculate the value today—in other words, the “present value”—of this stream of cashflows. Since money in the future is worth less than money today, you reduce the present value of each of these cashflows by your 10% discount rate. Specifically, the first year’s cashflow is worth $90.91 today, the second year’s cashflow is worth $82.64 today, and the third year’s cashflow is worth $75.13 today. Adding up these three cashflows, you conclude that the DCF of the investment is $248.68. Is DCF the same as net present value (NPV)? No, DCF is not the same as NPV, although the two are closed related concepts. Essentially, NPV adds a fourth step to the DCF calculation process. After forecasting the expected cash flows, selecting a discount rate, and discounting those cash flows, NPV then deducts the upfront cost of the investment from the investment’s DCF. For instance, if the cost of purchasing the investment in our above example were $200, then the NPV of that investment would be $248.68 minus $200, or $48.68. Download 45.29 Kb. Do'stlaringiz bilan baham: 
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