A discounted cash flow or DCF model is a style of calculation linking streams of future money flows to lump sum amounts.
Discounted cash flow models have a range of business-related applications, and are used extensively by economists, accountants, actuaries, engineers, business valuators, finance professionals, and others.
For example, a company may wish to finance a project if (and only if) the Internal Rate of Return exceeds 10% per year.
The anticipated development costs for the project may be large for the initial year.
On the other hand, significant revenues are anticipated for Year 2 onward.
The company directors rely on a DCF model to help determine whether or not the project's Internal Rate of Return exceeds their 10% threshold.
Discounted cash flow models also have important applications in everyday life that are often overlooked.
For example, consider automobile dealers who advertise low finance rates to prospective clients.
From a car buyer's perspective, low finance rates are understood to be good, since they mean lower monthly payments.
By using a DCF model, a buyer can determine the monetary value on the low finance rate offer.
Everyday use of a Discounted Cash Flow model would include (but would not be restricted to) the following:
Through the above (and other) practical applications, Discounted Cash Flow models can assist all of us in achieving our personal financial goals.
Discounted cash flow models have a range of business-related applications, and are used extensively by economists, accountants, actuaries, engineers, business valuators, finance professionals, and others.
For example, a company may wish to finance a project if (and only if) the Internal Rate of Return exceeds 10% per year.
The anticipated development costs for the project may be large for the initial year.
On the other hand, significant revenues are anticipated for Year 2 onward.
The company directors rely on a DCF model to help determine whether or not the project's Internal Rate of Return exceeds their 10% threshold.
Discounted cash flow models also have important applications in everyday life that are often overlooked.
For example, consider automobile dealers who advertise low finance rates to prospective clients.
From a car buyer's perspective, low finance rates are understood to be good, since they mean lower monthly payments.
By using a DCF model, a buyer can determine the monetary value on the low finance rate offer.
Everyday use of a Discounted Cash Flow model would include (but would not be restricted to) the following:
- Mortgage Refinancing: For homeowners with a fixed-rate mortgage, refinancing often involves paying a penalty.
A DCF model can be used to calculate whether the interest savings exceed the penalty cost - First-Time Home Ownership: First time home ownership involves many new costs, and can be intimidating to many of us.
A DCF model can help by comparing long term home ownership costs against rental costs - Lease or Own Vehicle: A DCF model can help car shoppers in their decision whether to buy or lease a vehicle
Through the above (and other) practical applications, Discounted Cash Flow models can assist all of us in achieving our personal financial goals.
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