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Financial Analysis Management

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Financial Analysis & Management
Discounted cash flow techniques

Discounted cash flow is a method used to evaluate a company based on the concept of time value of money, cash flows of the future are estimated then discounted to their present value, There are four discounted cash flow techniques which are; Net present value technique(N.P.V), Internal rate of return technique(I.R.R), Discounted payback technique and The profitability index technique (P.I) and every one of those techniques has its own purpose(Alfred, et al, 1971)

DCF Advantages|DCF Disadvantages|
· Theoretically, it’s the most rational method of valuation.· It depends on future estimations rather than historical results.· It focuses on cash flow generation and less affected by accounting practices.· It allows for the different business components to be valued separately or to value the whole business.· Ease of use· Convenient for both equity shareholders and debt holders.|· Accuracy of valuation highly depends on the quality of the assumption; any wrong inputs will result in wrong outputs, "Garbage in, Garbage out".· Any slight changes in inputs can cause large changes in the outputs.· Depends on the ability of user to predict future cash flows accurately or not.|
(www.macabacus.com, valuation, 5/4/2013)
The Discounted cash flow method is better than compounding cash flow because discounting cash flows gives us the Present value of the money, and the present value of money is more useful in finance.
Net Present Value (N.P.V) :
The Net Present Value Method Depends on comparing the money value in the present with same money's future value, and taking into account the inflation and returns, if N.P.V of an investment is positive then the investor should accept the investment, and if the N.P.V of the investment in negative, then the investment should be rejected(Dayananda, et al,2002)....

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