Discounted cash flow (DCF) model is one of the most used valuation methods to determine the value of a company or any cash flowing asset. Normally, a DCF model is an add-on to an existing, working financial model as to calculate the net present value by discounting the projected cash flows. There are three important elements that you need to consider when calculating the DCF value.
- Free Cash Flow to Firm (projected cash flows)
- Weighted Average Cost of Capital (discount rate)
- Time period used for valuation
The main concept of the DCF Model is to consider the time value of money. As you already know, as time passes by, the value of money constantly changes. Basically, what used to be less might be more in the future and vice versa. The DCF Model will be helpful in calculating of what could be expected in the future such as potential investment opportunities and other interests.
Most users prefer using the DCF Model due to its straightforward approach on calculating the present value. For example, if a company purchases an asset with an expected life of 5 years, the model will then calculate the future value of said asset by discounting it to find the present value. In cases for business acquisition, the need to determine a terminal value is essential as to put an end period of the DCF Model.
Though it may sound simple enough to build a DCF model, you would still need the required know-how as to ensure that the model is according to the state of the economy, trends, and other factors that could affect the variables in the model. To get a better understanding on how to build a DCF Model, you can take a look at eFinancialModels. There, you’ll be able to acquire and download industry-specific DCF model templates which you can use as a reference once you build your very own DCF valuation model.