discounted cash-flow (DCF)

Value of the anticipated revenue stream from an investment as at today or on any given date. Because money can grow by itself (when placed in an interest earning account) a dollar received today is less valuable than a dollar received in the future. This quality (the 'time value of money') makes choosing among investment opportunities (requiring different sums, and having different maturity periods and rates of return) a convoluted process. Therefore, DCF techniques are applied to 'bring-back' (discount) the anticipated returns to a common ground their present value (PV). Two basic DCF methods are the net present value (NPV) method and the internal rate of return (IRR) method, both of which take into account the time-value of money, and are similar to the methods used in computing interest-income on bank deposits. (1) In NPV method, the anticipated total cash-inflows (returns) are multiplied with a discount-rate to bring them back to their PV. The initial investment amount and other cash-outflows (costs) are subtracted from the PV to arrive at the net PV of the investment. A positive NPV indicates a desirable investment project. (2) The IRR is that discount rate at which the PV of the anticipated total cash inflows is equal to the PV of the anticipated total cash outflows, or the rate at which NPV is zero. IRR is determined through trial-and-error calculations using a mathematical formula (included with most spreadsheet programs) or a graph. IRR higher than the minimum acceptable rate of return (called hurdle rate) indicates a desirable investment project. Discounted cash flow analysis is Called also capitalization of income.