DCF Formula Calculations

In financial modeling, discounting is the process of translating future cash flows into present value. It allows analysts to make meaningful comparisons and assess the true value of a stream of income over time.

The Mathematical Basis

The most foundational formula in DCF valuation is:

$PV = \frac{FV}{(1 + r)^n}$

Where:

• PV - Present Value;

• FV - Future Value (e.g., $50,000);

• r - Discount Rate (e.g., 10% or 0.10);

• n - Number of periods (e.g., years).

This formula reflects compound discounting—each additional year pushes the cash flow further into the future, reducing its value more significantly.

Real-World Application

While the formula method is essential for understanding the logic, professionals rarely calculate present values manually in real-world scenarios. Instead, they use:

• Excel functions like =NPV(rate, value1, value2, ...);

• Financial calculators;

• Modeling software.

However, knowing the math builds intuition. For example, you'll quickly recognize that:

• A higher discount rate makes future cash flows less valuable;

• A longer time horizon shrinks present value faster.

Discounting is the reverse of compounding. If compounding grows money over time, discounting shrinks future money to today's terms.