Valuating a Company by DCF (Discounted Cash Flow).
Discounted cash flow (DCF) is a valuation method used to estimate the value of an investment based on its future cash flows. DCF analysis attempts to figure out the value of a company today, based on projections of how much money it will generate in the future.
DCF is calculated as follows:
- CF = Cash Flow
- r = discount rate (WACC)
- DCF is also known as the Discounted Cash Flows Model
DCF = CF(n) / (1 + R)n
n stands for Cash flow for Multiple years. Consider Cash Flow for next 5 Years.
A challenge with the DCF model is choosing the cash flows that will be discounted when the investment is large, complex, or the investor cannot access the future cash flows. The valuation of a private firm would be largely based on cash flows that will be available to the new owners.
DCF analysis also requires a discount rate that accounts for the time value of money (risk-free rate) plus a return on the risk they are taking.
Net Present Value (NPV)
Takes into account the Company's Current Cost of Capital in the form of WACC.
(Weighted Avg Cost of Capital).
If NPV is greater than 0, then mostly the Investment is Profitable. (Investors can Invest).
if NPV=0. We do not make additional Money. (Break Even).
For Entrepreneurs and Investors use NPV.
Internal Rate of Return (IRR):
IRR is the Yield of an Investment Expressed as a percentage.
If the IRR > WACC then's Project rate of Return is greater than it's Costs.