Economics
Discounted Cash Flow Analysis
Quick fact
Discounted cash flow analysis helps investors determine if an investment will be profitable by converting future cash flows into their current value.
Why this is interesting
Imagine you have two investment options: one gives you $100 today, and the other gives you $100 in a year. Which is better? It's not just about the amount—it's also about when you get it.
Read the full explanation
Understanding Discounted Cash Flow Analysis
Discounted cash flow (DCF) analysis works by taking a company’s or project’s expected future cash flows and adjusting them to reflect the time value of money. This means that a dollar today is worth more than a dollar in the future because it can be invested and earn returns over time.
A deeper explanation
The core idea behind DCF is that money has a time value—so to compare cash flows from different periods, they must be adjusted to their present-day equivalent. This is done using a discount rate, which represents the return an investor could expect from alternative investments with similar risk. By summing up all these discounted future cash flows, we arrive at the net present value (NPV) of the investment. If the NPV is positive, it suggests the project or investment is worth pursuing.