Discounted cash flow (DCF)
Valuing a series of future cash flows by converting each one to today's dollars and adding them up.
Value = CF1 ÷ (1 + r) + CF2 ÷ (1 + r)^2 + … + CFn ÷ (1 + r)^n
Explanation
A discounted cash flow (DCF) calculation is present value applied to many payments at once. You list each expected cash flow and when it arrives, divide each by (1 + r) raised to the number of periods until it arrives, and add the results.
The discount rate r represents what you could earn elsewhere with similar risk, sometimes called your opportunity cost or required return. A higher rate makes distant cash flows count for less. Unlike the annuity formula, DCF works even when payments are uneven, which makes it the general-purpose tool.
DCF is only as good as its inputs. Projected cash flows are estimates, and the discount rate is a judgment call. Running the same calculation with a few different rates is a simple way to see how sensitive the answer is.
In scenarios, the app uses DCF-style discounting when it values income streams (like a pension or rental income) in today’s dollars, and when it compares options whose costs and benefits land in different years.
Example
An investment is expected to pay $2,000 next year, $2,500 the year after and $3,000 in year three. Your discount rate is 6%.
| Year | Cash flow | Discount factor | Present value |
|---|---|---|---|
| 1 | $2,000 | 1.06 | $1,886.79 |
| 2 | $2,500 | 1.06^2 = 1.1236 | $2,224.99 |
| 3 | $3,000 | 1.06^3 = 1.1910 | $2,518.86 |
| Total | $7,500 | $6,630.64 |
The cash flows add up to $7,500, but at a 6% discount rate they are worth about $6,631 today. If the investment costs less than that, it beats your 6% alternative; if it costs more, it does not.