What is the discounted cash flow - Read useful advice
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As used discounted cash flow
Discounting cash flows is a method of assessment, which allows to determine the size of future benefits. With this method determines the present value of the company, without regard to the price-earnings competitive firms. Venture capitalists bought discounted cash flow analysis to determine the future return on investment.
Discounting is often used for the analysis of real estate. Taking into account not only cash but also other benefits: unrealized losses, tax credits, net revenue. The purpose of the discount - to evaluate the possible economic benefits and to calculate the amount of investments in the company.
Steps for applying the discounted cash flow
Discounting takes place in six stages. First, you prepare accurate forecasts about possible operations of the organization in the future. What are they more precisely, the greater the confidence of investors. Next estimated positive and negative cash flows for each year of the forecast, calculated annual increase funding in the future. It will calculate the final value of the company for the last year of the projection. Determined by the discount factor. This figure - one of the key elements of the cash flow analysis. It reflects the existing risks.
Discounted rate applies to the excess and deficiency of funds in each year of the forecast and the final cost of the project. The result is a value that determines the size of the contribution for each year. If you add these values, get the current value of the company. At the conclusion of the analysis is performed subtraction existing borrowings from the present value of future cash flows. Thus calculated assessment of the current cost of the project.
Despite the technical complexity of the calculation, discounting cash flows is based on the simple idea that current cash more expensive future. That is the return on financial investments exceed the current value. It makes no sense to invest in the project one hundred dollars just to get in the future the same amount. A much more attractive idea to invest a hundred today to tomorrow to receive the one hundred and twenty.
As with all other methods of valuation, discounting has disadvantages. Chief among them is that by focusing only on the future cash flows, it ignores external factors - the ratio of income and stock price, etc. In addition, because the method requires accurate prediction, it is necessary to know very well the history of the market and the nature of the business being valued.
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