This video opens with an explanation of the objective of a discounted cash flow (“DCF”) model. In DCF analysis, essentially what you are doing is projecting the cash flows of a company, project or asset, and determining the value of those future cash flows today. DCF analysis is focused on the Time Value of Money.
- Time Value of Money: A certain amount of money today has greater buying power today than the same amount of money in the future.
- Present value is determined by your cost of capital.
- In this video, to simplify the exercise and focus on the mechanics of building a model, we assume a cost of capital of 10%.
- This cost of capital is applied to the projected cash flows of a boat (asset).
- DISCOUNT FACTOR: The calculation used to discount the value of projected cash flows to determine present value.
- In the template below you can see the same projected cash flow for each year, and how a 10% cost of capital affects the value of those cash flows in the PV calculation.
- It also makes it easy to demonstrate that the value determined using Terminal Value is equivalent to the value realized if you project the cash flows of the boat far enough in to the future (see video).