📉 Discounted Cash Flow (DCF) Analysis Example

The Discounted Cash Flow (DCF) method estimates an investment’s intrinsic value by projecting future cash flows and discounting them back to present value. Here’s a practical example:

Step 1: Estimate Future Cash Flows

Suppose a company generated $1,000,000 in cash flow this year. Based on a 10% annual growth rate, the projections are:

Year 1: $1,100,000
Year 2: $1,210,000
Year 3: $1,331,000

Step 2: Determine the Discount Rate

Assume the company’s WACC (Weighted Average Cost of Capital) is 8%. This is the rate we’ll use to discount future cash flows.

Step 3: Calculate Present Value of Cash Flows

The present value of each year’s cash flow is calculated using the formula:

Where:

PV = Present Value
CF_t = Cash Flow in year t
r = Discount rate (8%)
t = Year

Applying the formula:

Year 1 PV = $1,100,000 / (1.08)¹ ≈ $1,018,518
Year 2 PV = $1,210,000 / (1.08)² ≈ $1,037,037
Year 3 PV = $1,331,000 / (1.08)³ ≈ $1,058,201

Total PV of Cash Flows (Years 1–3): ≈ $3,113,756

Step 4: Compare with Current Price

If the company’s stock has a market value of $2,800,000, the DCF suggests it is undervalued because the intrinsic value ($3.11M) is higher.

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