Analysing discounted cash flow technique for investment decision.

Expert Solution

Discounted cash flow (DCF) is a method used to determine the present value of an investment based on its future cash flows. The value of the investment today is computed based on the future cash flow projections.

The present value of future cash flows is computed by using a discount rate. Companies use the weighted average cost of capital for this purpose.

DCF is based on the concept of time value of money. In this concept it is assumed that a unit of money today is worth more than a unit tomorrow. DCF method is appropriate for analysis where the money is paid in the present with the expectations of receiving more money in the future.

If the present value of cash flow or discounted cash flow (DCF) is more than the present value of the investment cost, the investment is considered to be profitable. Investors can thus make investment decisions by comparing Discounted cash flow with Investment cost. DCF is computed by using the following formula;

= Cash flow for First year

= Cash flow for Second year

= Cash flow for Third year and so on....

The value calculated by using the formula is compared with Investment cost to take investment decision.

jeff jeffy answered 1 year ago

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