Discounted cash flow (DCF)
Principles of Finance glossary · Time Value of Money
Definition
A valuation method that computes present value by discounting forecasted free cash flows at a risk-appropriate rate (WACC for FCFF, cost of equity for FCFE). The two-stage form sums an explicit forecast period and a terminal value, with the terminal value often representing 70%+ of total enterprise value.
Discounted cash flow (DCF) in plain English
DCF is a way to figure out what a business or investment is really worth today by asking: how much cash will it hand me in the future, and what is that future cash worth right now? Because future money is worth less than money today, you 'discount' each year's expected cash back to present value and add it all up. Since you can't forecast forever, you predict cash flows for a handful of years explicitly, then tack on a 'terminal value' — a lump estimate for everything after that — which often makes up the majority (70%+) of the total. It's like valuing an apple tree not by its wood, but by adding up all the discounted-to-today value of every apple it will ever grow.
Also called: DCF
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