Discounted cashflow

nosaj

Can i have explanation on discounted cashflow, thanks for your help

SandyHood

The annual value of the net cash flow of a project or business adjusted using the cost of capital to give the value of that future cash flow at today's value.

If I borrow money on an overdraft at 10% per year, and expect to earn £1,100 as my net cash flow in one year's time, how much is that worth today?

Well the cost of capital of 10% means that my net cash flow needs to be "discounted" by using 10% to bring it down to the value it is worth today.

In this example, the numbers hopefully help. To have £1,100 at the end of the year at a 10% rate I would put £1,000 in the bank today.

Rather than divide by 110%, AAT questions will give a discount rate for each year. So we would multiply £1,100 by the 10% discount rate for 1 year (0.909)
£1,100 x 0.909 = £999.9 which is near enough to £1,000 for this type of analysis.

Thus a discounted cash flow calculation is a technique of adjusting future cash flows to give an equivalent present day value.

nosaj

thanks Sandy, i understand clearly I want to go go in exam with a clear understanding.