Talk:Discounted cash flow

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Would it be possible to add an example to this page? After reading it's still kind of unclear. Iflipti 04:29, 22 May 2005 (UTC)

• Response from User:Ertyqway, 21 April 2006: Done.

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I would like to see a correlation of discounted cash flow to the fair value of a share of stock. I have often heard of discounted cash flow being used as a way to value a stock however I am having trouble equating this to stock price.--69.249.154.41 01:44, 30 October 2005 (UTC)

Resonse to the above comment: Equity analysts develop their own proprietary models of what they expect the dividends and future stock price to be. Then those are discounted to the present using the DCF model. When one compares their model to the market price of a share, this is a source of buy or sell recommendation because they may not be the same. Of course, the model is only as good as the forecasted dividends and predicted dtock price.

[edit] Discount cash flow versus nominal cash flow

Which cash flow is best to use for evaluating real estate investment discount or nominal cash flow. Why?

Response: Expected future cash flows that do to the owner in nominal (not real) terms. In real estate, this is normally called operating income. These are the cash receipts to the owner from which he or she derrives value.

• Response from User:Ertyqway, 21 April 2006: Future cash flows for real estate transaction should only be considered in discounted, not nominal, terms. In fact, a real estate pro forma is not considered complete without a full DCF analysis. A complete DCF for a real estate transaction must include all expected cash flows, positive and negative. This not only includes net operating income, but also tax shelter value, built-up equity, and capital appreciation. For a real estate development project, further cash flows must be included in the analysis: construction costs, marketing costs, proceeds from sale, commissions, permit fees, and a whole host of other cash flows. When I do DCF for my own projects, the analysis matrix is typically many pages long, broken out quarterly or monthly depending on the detail required.

[edit] Article substantially revised on 21 APR 2006

I have substantially re-written the article to include the entire DCF formula and a very simple example showing how DCF analysis is generally done and what it means. Also, the original article limited the calculation of the discount factor to opportunity cost only, while not really discussing where opportunity cost numbers come from or what they really mean. A discussion of risk factors (commonly used in real estate DCF) has been included. The article has also been linked to the "real estate" category, where it is often referenced.

For further discussion: there appear to be several finance articles that all cover similar ground. Among these are discounted cash flow, future value, present value, and net present value. These subjects are all intimately related to one another (especially DCF and NPV), and should perhaps be collected together somehow.

Ertyqway

Thanks for the awesome article, this so saved me mega time in my capital costs class for engineering.

Ditto. Article is bangin'. Financial markets exam in two weeks. Keep up the good work

[edit] Large re-write March 2007 - opinions?

I have moved comments from user to bottom of this page, as traditional.--Gregalton 13:54, 1 April 2007 (UTC)

I have several problems with that article. It starts with an introduction that describes what is going on. Then we have a section Mathematics that contains some formulaes without giving the reader a clue qhat is going on (what has this to do with cash flows, values or cost of capital?). The exmaple (in my opinion) complicates the stoty even more - how do we proceed if we have different cash flows? Is that approach always allowed? Does it lead to the correct value? Then one citation and that's it. Since I am interested in that subject I take the freedom to erase the formulas. Examples are fine if you know what is going on, otherwise they can confuse people: This example is particular flawed since it calculated the net present value of an uncertain income stream with riskless interest rates. Where are all those numbers coming from? Can they be choosen arbitrarily? Or is there a rule that forces us to take particular interest rates? And I can add a lot more questions... User:al64 29 March 2007 (UTC)

I disagree with most of this evaluation but would like opinions of others. I think the content (not from me) was previously better and more complete, and examples useful. I previously reverted as I think this gets order wrong, definition before history, as well as blanking most of page. I think additional content addressing the question posed by al64 above would be useful, but do not see how the modified text addresses any of these questions. And in general, would suggest that we should be more cautious about deleting content, as opposed to adding detail, references and refining existing. (Ok, there are plenty of exceptions). Comments from other users above have been positive, which leads me to believe this is not an article where wholesale change is needed - although a lot of work is needed.--Gregalton 13:54, 1 April 2007 (UTC)

OK, let me put it this way: Let us talk about what should be added to the text. We had an example, but the problem was that this example got us to believe we understood something although it raised in fact more questions than it gave answers (where were those numbers coming from, when can we in fact calculate like the authors suggested, is such a calculation always successfull...). What should be added to that text or the topic? For example, a long text about CAPM is in my opinion misleading, since CAPM is an equilibrium model about one period (although there are some extensions to multiperiod) and valuation is in fact a multiperiod problem etc. Some sentences about cost of capital should be moved to the topic cost of capital and the same applies to cost of equity and cost of debt. For me, Discounted Cash Flow is just like a headline, that now is to be distribbuted into several sections. Al64 2 April 2007 (UTC)

I must have missed something - I don't see any mention of CAPM in this article. What does that have to do with it? Please, feel free to edit and add, and correct, but I'm going to go back to the previous version. Despite its weaknesses, it was more complete.

And I'm not sure I understand what it is you're suggesting in concrete terms. Each of your points can simply be addressed directly by editing into the existing text.--Gregalton 15:11, 2 April 2007 (UTC)

OK, I am commenting to the current version:

• It starts with time value of money. The first line has an interest rate i that is somehow changed to a rate d. Why? What is the relation between those two?

• The next line gives us a simple NPV formula. This formula makes only sense for certain cash flows, not for uncertain ones (than you need expectations). I do not see this assumption anywhere in that section.

• It is worthless having a formula for certain cash flows and no formula for uncertain cash flows. What changes with uncertainty?

• The last sentence says that this can be used as net present value. That is wrong: Net present value is the difference between market price minus present value (DPV).

• The internal rate of return is then mentioned. As anyone who hast studied business or finance should know, this is a very bad advice if cash flows change sign.

• The example of buing a house the comparison is not correct (complicating the example): you should compare renting and buying, hence you have to add fictious rent payments for the house. I suggest that a much easier example would be appropriate.

• Also the didactics is bad: The example starts with the wrong calculation. As people from teaching will tell you the better way to present a story is to start with the simplest example possible (one period I would suggest),present a correct calculation, then say something about why the wrong way to calculate is indeed wrong and then continue to the more complicated cases.

• Then a risk factor of 5% is added. Where is that risk factor comming from? Is there a theory for that or is it just taken from the air? If it is beyond the scope, why is no reference given?

• The main idea underlying the net present value is arbitrage. So why not saying it? The word arbitrage does not even appear.

• In the main text some links appear: Adjusted present value, Total cash flow, Flow to equity. Why are they mentioned again on the bottom? Some links are not mentioned there - why?

Al64 4 April 2007 (UTC)