Definition of discounted cash flow

Discounted cash flow is a way of finding out whether a capital or securities investment is worth making. Using the net present value method, income expected from the asset during each year of its future life is discounted, i.e. reduced, to allow for the delay in receiving that income, using an interest rate (discount rate) based on the cost of capital.

If the total of these discounted annual returns is greater than the capital sum needed to buy the asset now, the investment may be considered profitable. The internal rate of return method determines the interest rate (the average rate of return) at which the present value of future cash flows is equal to the cost of the investment now. You then make your decision on the basis of that yield.


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