To find discounted cash flow is necessary for taking better investment decisions. Discounted cash flow can tells us what is value of future cash flows at present time. Through discount rate, we can find present value of total cash outflow and present value of total cash inflows. If present cash inflow value is more than present cash outflow value, we can take the decision to invest our cash in that asset.
Now, we come to the steps of finding discounted cash flow :
1st Step : To Calculate the Discount Rate
For finding discounted cash flow, we need to calculate discount rate. Discount rate is calculated on the basis of interest on risk free investment and rate on average risk in investment. For example, if we invest our cash in Govt. FD, we get 4% interest. It means, today invests Rs. 100 value is more than after one year investing of Rs. 100 due to time value of money. But in discount rate, we will take risk free rate + rate for taking risk. It means, if FD's interest rate is 4%, then normal discount rate will be for other time of investment 5 % to 10%.
2nd Step : To Calculate the Discounted Cash Flow
By using the formula of discounted cash flow after calculating the discount rate, we can find discounted cash flow.
Formula of Calculating Discounted Cash Flow
= cash flow in future period/(1 + Discount rate)^Time Period
For example, you want to present value of your investment (Cash outflow) of RS. 100,000 which you have invested in 10 years. Discount rate is 5%
Present value of this cash flow will be
= 1,00,000 / (1 + 5/100)^10 = RS. 45248.86. It means, if we invest only Rs. 45248.86 present time, it is equal to invest Rs. 1,00,000 after 10 years.
Now, we come to the steps of finding discounted cash flow :
1st Step : To Calculate the Discount Rate
For finding discounted cash flow, we need to calculate discount rate. Discount rate is calculated on the basis of interest on risk free investment and rate on average risk in investment. For example, if we invest our cash in Govt. FD, we get 4% interest. It means, today invests Rs. 100 value is more than after one year investing of Rs. 100 due to time value of money. But in discount rate, we will take risk free rate + rate for taking risk. It means, if FD's interest rate is 4%, then normal discount rate will be for other time of investment 5 % to 10%.
2nd Step : To Calculate the Discounted Cash Flow
By using the formula of discounted cash flow after calculating the discount rate, we can find discounted cash flow.
Formula of Calculating Discounted Cash Flow
= cash flow in future period/(1 + Discount rate)^Time Period
For example, you want to present value of your investment (Cash outflow) of RS. 100,000 which you have invested in 10 years. Discount rate is 5%
Present value of this cash flow will be
= 1,00,000 / (1 + 5/100)^10 = RS. 45248.86. It means, if we invest only Rs. 45248.86 present time, it is equal to invest Rs. 1,00,000 after 10 years.
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