Discounted Cash Flow (DCF)

Discounted Cash Flow helps you estimate whether the current price of an investment looks high or low compared with the present value of its expected future cash flows. It does not tell you what the market price will do next.

• DCF converts future cash flows into their value today.
• The basic formula is CF ÷ (1 + r)ᵗ for each future cash flow.
• A higher discount rate gives a lower present value, other things remaining the same.
• DCF usually needs forecasts for cash flow, a discount rate, and terminal value.
• Terminal value estimates the value after the detailed forecast period.
• Small changes in assumptions can cause a large change in the final valuation.

DCF is therefore an estimate, not an exact price. Check the assumptions behind the number before using it to judge an investment.

Discounted Cash Flow is a valuation method that estimates the present value of expected future cash flows.

You first estimate the cash an investment or business may generate.

You then reduce, or discount, each future cash flow to its present value.

Finally, you add those present values together.

DCF can be used for assets where future cash flows can be estimated, including businesses, shares, projects, real estate, bonds, and other long-term assets.

The method becomes less reliable when future cash flows are highly unpredictable.

DCF can give you an estimated value to compare with the share's current market price.

Suppose your DCF calculation gives a hypothetical share value of ₹120.

The market price is ₹150.

The market price is ₹30 higher than your DCF estimate.

Now suppose the market price is ₹90.

It is ₹30 below your DCF estimate.

This does not automatically mean you should buy at ₹90 or avoid the share at ₹150.

Your DCF value depends on forecasts about future cash flows, growth, risk, and other assumptions. If those assumptions are wrong, the ₹120 estimate can also be wrong.

A basic DCF calculation has four main steps.

1. Estimate future cash flows

Forecast the cash the business or investment may generate.

For a business valuation, analysts often work with free cash flow rather than simply using revenue or accounting profit.

The forecasts can depend on items such as:

• sales,
• operating costs,
• taxes,
• working capital,
• capital expenditure, and
• future growth.

The further you forecast into the future, the more uncertain the numbers can become.

2. Choose a discount rate

The discount rate reflects the time value of money and the risk attached to future cash flows.

A riskier cash flow generally requires a higher discount rate than a more predictable one

For company valuation, the appropriate rate depends on the type of cash flow being valued.

For example, free cash flow to the firm is commonly discounted using the company's weighted average cost of capital.

3. Calculate the terminal value

A business may continue operating after your detailed 5-year or 10-year forecast ends.

Terminal value estimates the value of cash flows expected after that forecast period.

Because terminal value can form a large part of a DCF valuation, the assumptions used for it can materially change the answer.

4. Discount and add the values

Discount each forecast cash flow and the terminal value back to today.

Then add them together.

The result gives the estimated present value based on your assumptions.

What is the DCF formula?

The basic Discounted Cash Flow formula is:

DCF = Σ [CFₜ ÷ (1 + r)ᵗ]

Where:

• CFₜ = cash flow expected in period t
• r = discount rate
• t = time period
• Σ = total of all discounted cash flows

The formula simply brings each future cash flow back to today's value.

Simple one-year example

Suppose you expect ₹1,10,000 after one year.

Your discount rate is 10% per annum.

Present value:

₹1,10,000 ÷ 1.10 = ₹1,00,000

So, at a 10% discount rate, ₹1,10,000 received after one year has a present value of ₹1,00,000.

The Discounted Cash Flow (DCF) formula is a valuation method used to estimate the intrinsic value of an investment based on its expected future cash flows. The core idea behind DCF is that money available today is worth more than the same amount in the future due to inflation, risk, and opportunity cost.

DCF Formula:
 DCF = Σ [CFₜ / (1 + r)ᵗ]

Where:
 CFₜ = Cash flow expected in period t
 r = Discount rate (often the cost of capital or required rate of return)
 t = Time period
 Σ = Sum of all discounted cash flows

In practice, you project future cash flows over a specific period and discount each of them back to their present value using the discount rate. These discounted values are then added together. If the calculated DCF value is higher than the current market price, the investment may be considered undervalued; if lower, it may be overvalued.

Consider a hypothetical business that is expected to generate these cash flows:

Assume a 10% annual discount rate.

The calculation becomes:

The business may generate ₹10 lakh over these 5 years, but those future cash flows are worth about ₹7.22 lakh today when discounted at 10% per annum.

This example does not include a terminal value.

That is important because a real business may continue generating cash after Year 5.

The cash flow should match what you are trying to value.

Two common approaches are:

When FCFF is used, analysts generally discount it using WACC to estimate enterprise value.

Debt and other relevant adjustments are then considered when moving from enterprise value to equity value.

When FCFE is used, the cash flow is discounted at the cost of equity to estimate equity value.

Using the wrong discount rate with the wrong cash flow can produce an inconsistent valuation.

No. DCF value and market price are different numbers.

Market price is the price at which the share currently trades.

DCF value is an estimate produced from assumptions about future cash flow and risk.

For example:

• Market price = ₹200
• Your DCF estimate = ₹175

The difference does not prove that the market price must fall to ₹175.

Another investor can use different assumptions and calculate a DCF value of ₹220.

DCF therefore gives an estimated value under a set of assumptions, not a guaranteed future market price.

DCF and the Price-to-Earnings (P/E) ratio answer different questions.

DCF can provide more detail about future cash generation.

However, it also requires more assumptions.

A P/E ratio is simpler but does not directly calculate the present value of future cash flows.

Using more than one valuation method can help you understand why different methods give different answers.

Discounted cash flows (DCF) is a widely used fundamental analysis method used by investors to assess the potential value of an investment. This method is based on the concept of time value of money (TVM), which states that the worth of a rupee today is higher than the worth of a rupee revived in future.

By applying a minimum rate of return, investors can bring the projected cash flows back to their present value and calculate an intrinsic value. Applicable for both long-term and short-term investments, DCF empowers investors to assess the potential value of investments with greater clarity and confidence.

Discounted Cash Flow estimates today's value of expected future cash flows by applying a discount rate. It can help you compare an estimated intrinsic value with a current price, but the result depends on forecasts for cash flow, growth, discount rate, and terminal value. Small changes in these assumptions can materially change the valuation, so DCF should be treated as an estimate and checked alongside other financial and valuation information.

Sources: 

Securities and Exchange Board of India (SEBI)

CFA Institute, Free Cash Flow Valuation, 2026 curriculum