TMP 120 Lecture 8 DCF Posting 021218B.ppt - Discounted Cash...

Discounted Cash Flows: Finding Value……
Choosing Between Investment Options
February 12, 2018
Dr. Karen Smith Bogart

Today
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Capital Budgeting
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DCF
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Assessing Value: 3 Approaches
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Blood Analyzer Homework Assignment

Capital Budgeting
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The future of a company lies in the investments it
makes today. Choices….
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Investment project proposals are the responsibility
of all managers in the organization.
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Capital budgeting is the financial evaluation of
project proposals.
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Weigh $$$ outlay (investment) today vs. expected
future benefits.

Discounted Cash Flows
Approach to decision-making:
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Discounted cash flow (DCF) analysis is the
backbone of modern financial analysis.
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DCF is used to evaluate project-related cash flow streams
whose costs and/or benefits extend over multiple years.
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A method to value a project, company or asset.
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Used all the time in real estate, banking and corporate finance.

Discounted Cash Flows
Would you rather have $200 today or $200
in one year?
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Assume there is no trick….
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Why? Advantages? Risks?

Time Value of Money
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Income today is real.
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Income received in the future is worth less than
the same income received now.
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Why? :
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Risk
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Inflation
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Uncertainty
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Missed opportunity to take, invest and earn interest.
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Opportunity Cost: Could have invested in alternative
projects

Discount (RISK) Rate
The discount rate reflects the risk associated
with the cash flows.
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Many investors would rather have their cash now.
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Investors want to be compensated for the delay.
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A “risk premium” is added which reflects the extra return investors
demand due to their risk.
Impact of risk:
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When the discount rate goes up: the present value goes down.
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When the discount rate goes down: the present value goes up.
Predicting the future is risky…
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Most discount rates include a “risk premium”
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Higher the project risk, the higher the discount rate should be
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Start-up biotechs: 30-40%
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Expansion project for established company: 5-15%
Discount

DCF Concept and Steps
Concept :
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A valuation method used to estimate the attractiveness of an
investment opportunity.
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DCF analysis uses future cash flow projections and
discounts them to arrive at a present value estimate which is
used to evaluate the potential for investment.
Steps :
1. Estimate the relevant cash flows.
2. Calculate the rate of return for the investment.
3. Compare the returns to your acceptance criterion.

Key Informational Needs
Information you need:
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n = number of periods (time )
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i = interest rate
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PV = present cash flows
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PMT = annuity stream of cash flows
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FV = future cash flow
****For ease, use a financial calculator phone app
(e.g. Ez Calculators)!

DCF Concept: Present Value
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Present Value :
The current worth of a future sum of money or stream of cash flows given a
specified rate of return.