How to Calculate Discounted Cash Flow
Discounted cash flow is a useful way of evaluating how much value investments will earn through their future cash flows and is a core part of how many investors operate. However, like many techniques used in investments, the formula for DCF can be one that takes a while to fully understand.
But what is the calculation for DCF, and why is it so important?
Understanding DCF
In simple terms, discounted cash flow is a way of valuing assets based on the earnings they will bring in at future dates. Rather than using the current value of the asset, DCF tries to work out the value based on how much money will be earned in the future.
The general idea behind the DCF calculation is to serve as a method of comparing different investment opportunities, making it easier to see which ones are going to provide the most profit. This simplifies the process of having to decide which of your current investment opportunities has the most long-term value, which is important if you are specifically looking for gains over a longer period of time.
What is The Formula For DCF?
The formula for Discounted Cash Flow is one that seems complicated on paper but is actually consistent across every single investment you use it on.
Cash flow/(1 + the discount rate of the cash flow) to the power of the life of the asset.
While this might sound complex at first, the general idea is to estimate the overall earnings of the investment based on its cash flow and overall “life” as an investment asset. This makes it a widespread metric among a lot of investment experts since it provides a useful estimate of the total returns of an investment over a set period of time.
Do You Need To Calculate DCF Manually?
While calculating your own DCF is certainly possible, it is often much easier to use online platforms and tools that can calculate it for you. A good example is the DCF stock calculator which you can find here, providing an easy way to calculate DCF valuation without having to worry about any complicated formulas.
Using a DCF calculator can streamline the entire process, making it significantly easier to compare different investment options without worrying about incorrect calculations or other errors. The less you have to do manually, the fewer chances there are for human error to get in the way of you having accurate, clear-cut estimates to work with.
However, it is also important to understand that even a DCF calculator can only offer rough estimates of the future cash flows of an investment. These are based on a number of different assumptions and estimates, such as the future earnings and price changes of an investment, which means that the accuracy is never 100%.
As such, you should always consider other factors when comparing investments. A good investor does not just use a single tool or formula to decide how much an investment is worth; DCF is useful but should be only one part of your decision process.
