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## Guide to the Discounted Cash Flow DCF Formula

This article breaks down the discounted cash flow DCF formula into simple terms. We will take you through the calculation step by step so you can easily calculate it on your own. The DCF formula is required in financial modelingWhat is Financial ModelingFinancial modeling is performed in Excel to forecast a company’s financial performance. Overview of what is financial modeling, how & why to build a model. to determine the value of a business when building a DCF modelDCF Model Training Free GuideA DCF model is a specific type of financial model used to value a business. The model is simply a forecast of a company’s unlevered free cash flow in Excel.

Watch this short video explanation of how the DCF formula works.

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### What is the Discounted Cash Flow DCF Formula?

The discounted cash flow (DCF) formula is equal to the sum of the cash flowValuationFree valuation guides to learn the most important concepts at your own pace. These articles will teach you business valuation best practices and how to value a company using comparable company analysis, discounted cash flow (DCF) modeling, and precedent transactions, as used in investment banking, equity research, in each period divided by one plus the discount rate (WACCWACCWACC is a firm’s Weighted Average Cost of Capital and represents its blended cost of capital including equity and debt.) raised to the power of the period number.

Here is the DCF formula:

Where:

**CF** = Cash Flow in the Period

**r** = the interest rate or discount rate

**n** = the period number

### Analyzing the Components of the Formula

##### 1. Cash Flow (CF)

Cash FlowCash FlowCash Flow (CF) is the increase or decrease in the amount of money a business, institution, or individual has. In finance, the term is used to describe the amount of cash (currency) that is generated or consumed in a given time period. There are many types of CF (CF) represents the net cash payments an investor receives in a given period for owning a given security (bonds, shares, etc.)

When building a financial model of a company, the CF is typically what’s known as unlevered free cash flowUnlevered Free Cash FlowUnlevered Free Cash Flow is a theoretical cash flow figure for a business, assuming the company is completely debt free with no interest expense.. When valuing a bond, the CF would be interest and or principal payments.

To learn more about the various types of cash flow, please read CFI’s cash flow guideCash FlowCash Flow (CF) is the increase or decrease in the amount of money a business, institution, or individual has. In finance, the term is used to describe the amount of cash (currency) that is generated or consumed in a given time period. There are many types of CF.

##### 2. Discount Rate (r)

For business valuation purposes, the discount rate is typically a firm’s Weighted Average Cost of CapitalWACCWACC is a firm’s Weighted Average Cost of Capital and represents its blended cost of capital including equity and debt. (WACC). Investors use WACC because it represents the required rate of return that investors expect from investing in the company.

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For a bond, the discount rate would be equal to the interest rate on the security.

##### 3. Period Number (n)

Each cash flow is associated with a time period. Common time periods are years, quarters, or months. The time periods may be equal, or they may be different. If they’re different, they’re expressed as a percentage of a year.

### What is the DCF Formula Used For?

The DCF formula is used to determine the value of a business or a security. It represents the value an investor would be willing to pay for an investment, given a required rate of return on their investment (the discount rate).

#### Examples of Uses for the DCF Formula:

- To value an entire business
- To value a project or investment within a company
- To value a bond
- To value shares in a company
- To value an income-producing property
- To value the benefit of a cost-saving initiative at a company
- To value anything that produces (or has an impact on) cash flow

Below is a screenshot of the DCF formula being used in a financial modelTypes of Financial ModelsThe most common types of financial models include: 3 statement model, DCF model, M&A model, LBO model, budget model. Discover the top 10 types to value a business. The Enterprise ValueEnterprise Value (EV)Enterprise Value, or Firm Value, is the entire value of a firm equal to its equity value, plus net debt, plus any minority interest of the business is calculated using the =NPV()NPV FunctionThe NPV Function is categorized under Excel Financial functions. It will calculate the Net Present Value (NPV) for periodic cash flows. The NPV will be calculated for an investment by using a discount rate and series of future cash flows. In financial modeling, the NPV function is useful in determining the value of a business function along with the discount rate of 12% and the Free Cash Flow to the Firm (FCFF)Free Cash Flow to Firm (FCFF)FCFF, or Free Cash Flow to Firm, is cash flow available to all funding providers in a business. debt holders, preferred stockholders, common shareholders in each of the forecast periods, plus the terminal valueTerminal ValueTerminal Value (TV) is the estimated present value of a business beyond the explicit forecast period. TV is used in various financial tools.

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### What Does the Discounted Cash Flow Formula Tell You?

When assessing a potential investment, it’s important to take into account the time value of money or the required rate of return that you expect to receive.

The DCF formula takes into account how much return you expect to earn, and the resulting value is how much you would be willing to pay for something to receive exactly that rate of return.

**If you pay less than the DCF value, your rate of return will be higher than the discount rate.**

**If you pay more than the DCF value, your rate of return will be lower than the discount.**

### Illustration of the DCF Formula

Below is an illustration of how the discounted cash flow DCF formula works. As you will see, the present value of equal cash flow payments is being reduced over time, as the effect of discounting impacts the cash flows.

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### Terminal Value

When valuing a business, the annual forecasted cash flowsCash FlowCash Flow (CF) is the increase or decrease in the amount of money a business, institution, or individual has. In finance, the term is used to describe the amount of cash (currency) that is generated or consumed in a given time period. There are many types of CF typically used are 5 years into the future, at which point a terminal valueKnowledgeCFI self-study guides are a great way to improve technical knowledge of finance, accounting, financial modeling, valuation, trading, economics, and more. is used. The reason is that it becomes hard to make reliable estimates of how a business will perform that far out into the future.

There are two common methods of calculating the terminal value:

- Exit multiple (where the business is assumed to be sold)
- Perpetual growth (where the business is assumed to grow at a reasonable, fixed growth rate forever)

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Check out our guide on how to calculate the DCF terminal valueDCF Terminal Value FormulaDCF Terminal value formula is used to calculate the value a business beyond the forecast period in DCF analysis. It’s a major part of a model to learn more.

### DCF vs. NPV

The total Discounted Cash Flow (DCF) of an investment is also referred to as the Net Present Value (NPV)NPV FormulaA guide to the NPV formula in Excel when performing financial analysis. It’s important to understand exactly how the NPV formula works in Excel and the math behind it. NPV = F / [ (1 + r)^n ] where, PV = Present Value, F = Future payment (cash flow), r = Discount rate, n = the number of periods in the future. If we break the term NPV we can see why this is the case:

Net = the sum of all positive and negative cash flows

Present value = discounted back to the time of the investment

### DCF Formula in Excel

MS Excel has two formulas that can be used to calculate discounted cash flow, which it terms as “NPV.”

Regular NPV formula:

**=NPV(discount rate, series of cash flows)**

This formula assumes that all cash flows received are spread over equal time periods, whether years, quarters, months, or otherwise. The discount rate has to correspond to the cash flow periods, so an annual discount rate of r% would apply to annual cash flows.

Time adjusted NPV formula:

**=XNPV(discount rate, series of all cash flows, dates of all cash flows)**

With XNPV, it’s possible to discount cash flows that are received over irregular time periods. This is particularly useful in financial modeling when a company may be acquired partway through a year.

For example, this initial investment may be on August 15th, the next cash flow on December 31st, and every other cash flow thereafter a year apart. XNPV can allow you to easily solve for this in Excel.

To learn more, see our guide on XNPV vs. NPV in Excel.

### More Helpful Resources

CFI’s mission is to help you advance your career. With that mission in mind, we’ve compiled a wide range of helpful resources to guide you along your path to becoming a certified Financial Modeling & Valuation Analyst (FMVA)®Become a Certified Financial Modeling & Valuation Analyst (FMVA)®CFI’s Financial Modeling and Valuation Analyst (FMVA)® certification will help you gain the confidence you need in your finance career. Enroll today! analyst.

Relevant resources include:

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- Internal Rate of ReturnInternal Rate of Return (IRR)The Internal Rate of Return (IRR) is the discount rate that makes the net present value (NPV) of a project zero. In other words, it is the expected compound annual rate of return that will be earned on a project or investment.
- Valuation MethodsValuation MethodsWhen valuing a company as a going concern there are three main valuation methods used: DCF analysis, comparable companies, and precedent transactions
- DCF Modeling TipsDCF Model Training Free GuideA DCF model is a specific type of financial model used to value a business. The model is simply a forecast of a company’s unlevered free cash flow
- Financial Modeling Best PracticesFree Financial Modeling GuideThis financial modeling guide covers Excel tips and best practices on assumptions, drivers, forecasting, linking the three statements, DCF analysis, more