WFU Law School
Law & Valuation
4.1.2 Required Return (Discount Rate)

4.1.3 Discounted Cash Flow (DCF) Model

The value of an investment is the present value of all expected future cash flows -- that is, cash flows discounted to present value. This can be expressed as

V0 = CF1/(1+i)1 + CF2/(1+i)2 + CF3 (1+i)3 + ... +CFn/(1+i)n
V0 = CFn / (1+i)n
V0
= value of asset at time zero
CFt
= cash flow expected at the end of year t
i
= discount rate
n
= time period

This method is widely used by business valuators and has become accepted in many legal contexts.

Example

How did the Desmond court apply DCF? After settling on the expected cash flows and the appropriate discount rate, the Tax Court applied the DCF model, also known as the "income" method. (More>>)

In one of his famous letters to shareholders, Warren Buffett writes:

[Intrinsic value is] an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses. Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life. The calculation of intrinsic value, though, is not so simple. (More>>)

4.1.2 Required Return (Discount Rate)

©2003 Professor Alan R. Palmiter

This page was last updated on: March 30, 2004