Fundamental Analysis

Discounted Cash Flow Model


The discounted cash flow method can be a little tricky to understand. In short, it’s a calculation that is used to estimate the value of a company based on it’s expected future cash flows.


The formula is as follows: (CF1/(1+r)^1) + (CF2/(1+r)^2) + (CFn/(1+r)^n). Where CF is the cash flow for a given year, where r is the discount rate and n is the additional years that you would add.  


The discount rate is calculated by using the formula: Market capitalisation/(market cap + debt) x cost of equity + debt/(market cap + debt) x cost of debt x (1−corporate tax rate).


Forecasted cash flows can be used in the model to predict future value. To estimate the future share price of a company, you would divide the discounted cash flow figure by the number of total shares outstanding.

Test your knowledge...

1. How much can you expect to earn from a cash investment?

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