Discounted Cash Flow

Discounted cash flow (DCF) is one of the most widely used valuation methods in finance. In fact, more than 80% of organizations use DCF to evaluate projects and investment opportunities, according to the 2026 AFP Cost of Capital Survey.

DCF is a type of financial model. Like all models, it seeks to reduce real-world complexities into something simpler to study — in this case, to make the best business decisions.

DCF helps estimate what an investment is worth today based on its expected future cash flows. It incorporates the time value of money, the concept that a dollar received today is generally worth more than a dollar received years from now due to the opportunity cost of how the funds could otherwise have been spent.

Additionally, DCF accounts for the inherent risk of an investment — such as entering a new country or launching a new product — by adjusting the rate used to discount those future cash flows.

By converting these projections into present value, decision-makers are able to compare opportunities on a like-for-like basis and make better-informed decisions regarding capital allocation. This makes DCF a practical framework for evaluating projects, acquisitions, equipment purchases and other investments.

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What Is Discounted Cash Flow?

Discounted cash flow is a financial modeling method used to estimate an investment's present value based on expected future cash flows. The future cash flows are projected over a defined period, then discounted back to the present using a chosen risk-adjusted rate — often the weighted average cost of capital (WACC).

DCF is used by FP&A professionals, treasury professionals, executives and investors to support decisions involving capital spending, business valuation and long-term strategy. If the present value of expected cash flows exceeds the current cost of the investment, it is likely to create value. But if it falls short, it’s typically rejected on financial merits, and assumptions are revised or compared against alternatives.

Discounted Cash Flow Model Excel Template

Building a DCF model in Excel helps finance teams identify and test assumptions, understand operational-financial connections and document investment decisions.

Using a standardized Excel template can help improve consistency, governance and transparency across investment reviews.

A well-structured template typically includes inputs for projected revenue, operating costs, taxes, capital expenditures, working capital needs and discount rate assumptions. It allows users to:

Understand how the model projects reactions to changing conditions.
Model multiple scenarios, such as base, upside and downside cases.
Test the sensitivities of key drivers by stress-testing them at different levels.

Download AFP’s DCF Model Excel template to build your own valuation model and test investment scenarios with confidence.

How to Calculate Discounted Cash Flow

DCF is calculated by estimating future cash flows for each year of a project or investment and discounting those amounts back to present value using a required rate of return. The formula is:

DCF = Σ(CFt / (1 + r)^t)

Where:

CF = cash flow in period t
r = discount rate
t = time period

For example, assume a project is expected to generate $100,000 next year and the discount rate is 10%. Using the discounted cash flow formula, the present value of that one-year cash flow would be:

PV = $100,000 / (1 + 0.10)^1 = $90,909

That means $100,000 received one year from now is worth about $90,909 today using a 10% required rate of return. Repeating this process across all projected years and adding the present values together produces the total DCF estimate.

How to Perform Discounted Cash Flow Analysis

DCF analysis is based on forecasted cash flows rather than operating income, which is subject to accounting treatments, such as revenue recognition and expense matching.

Grounded in realistic operating assumptions based on business strategy, historical performance and market conditions, finance teams project revenue growth, margins, taxes, reinvestment needs and working capital impacts over a multi-year period.

Next, they select a forecast horizon. According to the 2026 AFP Cost of Capital Survey, the most common approaches are using a five-year horizon or modeling the life of a project.

Then, finance professionals estimate the terminal value, which represents the value of cash flows beyond the modeled horizon. Common approaches include:

Applying a perpetual growth rate.
Estimating what the business could be worth at the end of the forecast period using comparable market valuations, such as applying an ending multiple (e.g., 5x revenue at the end of the horizon).
Calculating the salvage value of an asset (e.g., what a delivery truck would be worth if sold after 5 years).

Many organizations improve DCF analysis by identifying the cone of uncertainty around a forecast. They use probabilistic tools such as Monte Carlo simulations, which apply parameters (e.g., demand, costs, interest rates, foreign exchange exposure and competitive conditions) to illustrate the full spectrum of projected upside and downside outcomes.

Discounted Cash Flow vs. Other Investment Decision Methods

DCF and net present value (NPV) are distinct components of the same process. DCF is the model that estimates the present value of future cash flows, whereas NPV is the output that subtracts the initial investment from those discounted cash flows to show value created or destroyed.

In other words, you use a DCF analysis to calculate an NPV; a positive NPV indicates the investment will clear the required return.

To ensure balanced decision-making, finance teams rarely rely on a single metric. Instead, they use a combination of methods to test assumptions, compare outcomes and evaluate risk from different perspectives.

Finance teams often evaluate investment decisions using several metrics in tandem to test reasonableness, compare outcomes and support more balanced decision-making.

Investment decision method	What it shows
Discounted cash flow	Present value of expected future cash flows
Net present value	Value created or destroyed by an investment after accounting for the initial cost
Internal rate of return	Annualized compound return derived from a capital investment’s cash flows
Payback period	How quickly an investment recovers its initial cost
Profitability index	Amount of present value cash flow expected per dollar invested

Advantages and Disadvantages of Discounted Cash Flow

DCF is popular because it focuses on fundamentals rather than market noise. It does this by emphasizing expected cash generation and explicitly accounting for the time value of money. It can also be tailored to each project, making it useful for internal capital budgeting decisions where market comparisons may be limited.

That said, DCF is only as strong as its assumptions. Small changes in revenue growth, margins, timing or discount rates can materially change valuation results.

Additionally, the terminal value can represent a significant share of the total valuation. If too much of a company’s worth hinges on cash flows projected far into the future, long-range assumptions should be scrutinized. In such cases, organizations often choose to leave the terminal value off entirely for certain investments.

DCF is less about producing a single “correct” number and more about creating a disciplined framework for decision-making — uncovering assumptions, standardizing comparisons with other projects and helping the team understand the project. The models can be powerful, but they are not crystal balls.

FAQs on Discounted Cash Flow

What is discounted cash flow used for?
DCF is commonly used to evaluate multi-year capital projects, acquisitions, equipment purchases, securities and business valuations. It helps decision-makers compare the expected return of an investment against its cost today. Because its value lies in analyzing the time value of money, it is not suited for projects shorter than a year.

What does discounted cash flow tell you?
DCF estimates what future expected cash flows are worth in present-day dollars, which largely indicates whether an opportunity is likely to create value based on the assumptions used.

What is the discount rate in discounted cash flow?
The discount rate reflects the required rate of return or opportunity cost of capital. Many companies use WACC because it incorporates the expected returns required by both debt holders and equity investors.

What is terminal value in discounted cash flow?
Terminal value represents the estimated value of all future cash flows beyond the designated forecast period, therefore serving as a major component of total valuation in a DCF model.