Discounted cash flow
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Revision as of 18:17, 19 February 2023
Developed by Oliver Skou Schwarz
This page will refer to the discounted cash flow (DCF) regarding projects and investments.
Discounted Cash Flow (DCF) is a method used to estimate the value of an investment or a project by projecting its future cash flows and then discounting them back to their present value.
The reason for using DCF is that an investment's value is equal to the sum of its expected future cash flows, discounted at an appropriate rate to account for the time value of money and the investment's level of risk.
Reference test [1]
Contents |
History
Origin
- Origin of the method
- Why was it "invented"?
- Who "invented" it?
The concept of discounted cash flow (DCF) has been used in various forms for centuries, but the modern version of DCF used in finance and investment analysis can be traced back to the early 20th century.
One of the earliest uses of DCF in its modern form was by Irving Fisher, an American economist, in his 1930 book "The Theory of Interest." Fisher used DCF to calculate the present value of a stream of future cash flows, which he called the "net present value" of an investment.
Fisher's work on DCF was groundbreaking and became an important part of finance theory. Since then, DCF has been widely used in financial analysis and valuation, including in corporate finance, investment banking, and portfolio management.
Use throughout history
How has it been used before?
- In the 1930s, DCF was used by economists such as Irving Fisher and John Maynard Keynes to analyze the impact of interest rates on investments and economic growth.
- In the 1950s, DCF gained popularity in the oil and gas industry as a tool for valuing oil and gas reserves. This was known as the "net present value" (NPV) method, which calculates the present value of expected cash flows from oil and gas reserves.
- In the 1960s and 1970s, DCF was used by corporate finance professionals to evaluate capital investment projects and to value businesses for mergers and acquisitions.
- In the 1980s and 1990s, DCF became widely used in the field of equity research, where it is used to value stocks and make investment recommendations to clients.
- Today, DCF is still widely used in all of these areas, as well as in other fields such as real estate investment and project finance.
Overall, DCF has been an important tool for investors, analysts, and managers in making informed decisions about investments, capital allocation, and strategic planning.
Math section
A section describing the mathematical expression in detail, so it is broken down into understandable parts. Including examples of how the calculation method works.
- Discounted Cash Flow (formula)
- Free cash flow
- Discount Rate
Application
A section explaining how and when to use the method, and what it is used with
- Time value of money
- Net Present Value (NPV)
- Working Average Cost of Capital (WACC)
Investments in Projects (references to NPV as well)
A section with specific reference to projects and investments in these, possible examples from real life application of it and other methods that are similar or (better/worse) in certain cases.
- Projects
- Real example
- How and when similar models were used
Pros and Cons
A section describing the main pros and cons of the methods, with a critical perspective on possible assumptions of the model.
Key takeaways
A brief section with concrete advice on how it should be applied for the reader - this may need to not be the last section, so it is easier to find.
References
Possible Sources: https://www.investopedia.com/terms/d/dcf.asp https://www.investopedia.com/terms/c/cashflow.asp https://www.streetofwalls.com/finance-training-courses/investment-banking-technical-training/discounted-cash-flow-analysis/ https://www.pmi.org/learning/library/project-investment-9384 (PROJECT INVESTMENT https://esfccompany.com/en/articles/economics-and-finance/investment-project-management/) (HISTORY https://www.jstor.org/stable/2490123?seq=8)
