Discounted Cash Flow Model (DCF) Definition
The Discounted Cash Flow Model can be used even if a company doesn’t pay a dividend or has unpredictable dividend returns.
Subscribe to the Finance Strategists YouTube Channel ↗
To calculate the value of a share using the Discounted Cash Flow Model, add up the value of future earnings, then discount the earnings by the weighted average cost of capital, or WACC.
Then, subtract net debt from the enterprise value to compute the company’s fair value and divide by the number of outstanding shares to calculate the value of a share.
Discounted Cash Flow Formula
The formula for DCF is as follows:
Take the future cash flows for year.
Then divide by one plus “r”, which represents the discount rate, or WACC, raised to the first power.
Then, add the future cash flows for year 2.
Divided by one plus “r”, or the WACC, raised to the second power.
Once you have the enterprise value, subtract the net debt of the company and divide by the number of outstanding shares.
Discounted Cash Flow Analysis
If the estimated value of a share using the Discounted Cash Flow Model is greater than the current value of a share, the DCF model suggests it is a buying opportunity.
The weakness of this model is that it relies entirely on future cash flows estimates, which are unknown.
Learn the basics of Cash Flow Statements, their objectives, and classifications in this article: Cash Flow Statement (CFS)
Discounted Cash Flow FAQs
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.