how does discounted cash flow dcf work 
the purpose of dcf analysis is to estimate the money an investor would receive from an investment adjusted for the time value of money the time value of money assumes that a dollar that you have today is worth more than a dollar that you receive tomorrow because it can be invested as such a dcf analysis is useful in any situation where a person is paying money in the present with expectations of receiving more money in the future for example assuming a 5 annual interest rate 1 in a savings account will be worth 1 05 in a year similarly if a 1 payment is delayed for a year its present value is 95 cents because you cannot transfer it to your savings account to earn interest discounted cash flow analysis finds the present value of expected future cash flows using a discount rate investors can use the concept of the present value of money to determine whether the future cash flows of an investment or project are greater than the value of the initial investment if the dcf value calculated is higher than the current cost of the investment the opportunity should be considered if the calculated value is lower than the cost then it may not be a good opportunity or more research and analysis may be needed before moving forward with it to conduct a dcf analysis an investor must make estimates about future cash flows and the ending value of the investment equipment or other assets the investor must also determine an appropriate discount rate for the dcf model which will vary depending on the project or investment under consideration factors such as the company or investor s risk profile and the conditions of the capital markets can affect the discount rate chosen if the investor cannot estimate future cash flows or the project is very complex dcf will not have much value and alternative models should be employed for dcf analysis to be of value estimates used in the calculation must be as solid as possible badly estimated future cash flows that are too high can result in an investment that might not pay off enough in the future likewise if future cash flows are too low due to rough estimates they can make an investment appear too costly which could result in missed opportunities discounted cash flow formulathe formula for dcf is d c f c f 1 1 r 1 c f 2 1 r 2 c f n 1 r n where c f 1 the cash flow for year one c f 2 the cash flow for year two c f n the cash flow for additional years r the discount rate begin aligned dcf frac cf 1 1 r 1 frac cf 2 1 r 2 frac cf n 1 r n textbf where cf 1 text the cash flow for year one cf 2 text the cash flow for year two cf n text the cash flow for additional years r text the discount rate end aligned dcf 1 r 1cf1 1 r 2cf2 1 r ncfn where cf1 the cash flow for year onecf2 the cash flow for year twocfn the cash flow for additional yearsr the discount rate example of dcf