When it comes to investment, you have to be wise enough to invest your hard-earned money. Is the investment worth it? In general, investment involves different levels of risks, and no one is certain whether you will win or lose. However, performing a Discounted Cash Flow analysis is a great way to arrive at an educated guess concerning your prospective investment. This article will dive more in-depth into how Excel Discounted Cash Flow analysis works and how it will help you make any investment decisions.
What is Discounted Cash Flow Analysis?
Discounted Cash Flow (DCF) analysis is a valuation technique used to estimate an asset’s worth based on the expected future cash flows. It aims to figure out the value of a particular investment today by predicting the money it will generate in the future. In other words, DCF analysis attempts to uncover how much money you can spend on investment right now to receive the desired return in the future. This technique applies whether you want to compute the value of other business, real estate, or any other capital investments. It will allow you to ascertain if such an investment is worthwhile.
Elements of Discounted Cash Flows
Under the time value of money principle, the DCF concept assumes that your dollar is worth more today than it is in future time. The elements of DCF analysis are summarized below to understand this concept better.
- Discount Rate: This is the rate to be used to discount your cash flows. It can be thought of how much money you will earn if invested in another account with a similar risk.
- Period of Time: The period covered in your analysis or the time frame required for your investment to earn the desired return.
- Projected Cash Flows: It is the cash flow projected to occur annually. This will be discounted at an annual rate to derive the present value estimate. The Net Present Value (NPV) will be used to determine the potential of a particular investment.
Conclusion: DCF Analysis is an excellent technique used to analyze whether an investment is worthwhile.
No matter how small or huge an investment is, it is always wise to analyze an investment using a reliable method before jumping out to the river and avoid making a sloppy mistake. There are plenty of Excel Discounted Cash Flow templates available here, which would help you make sound investment decisions.