The Discounted Cash Flow Appraisal Method is also used for larger businesses similar to the EBITDA method. To understand the Discounted Cash Flow Appraisal Method, one needs to understand the concept of the “time value of money.” If you invest a dollar and it earns you a 10% annual return, that dollar would be worth $1.10 in one year. Therefore, if I agree to give you a dollar in one year, it is not actually worth the same as if I gave you a dollar today. Since you aren’t able to invest it and let it grow over time, you would only have $1.00 next year instead of $1.10. To determine what a dollar in the future is worth today, I have to discount the future value to get to the present value. Therefore $.91 today invested at 10% will be worth $1.00 in one year ($.91 + $.09 interest = $1.00).
This principle is the basis for the Discounted Cash Flow Appraisal Method. Generally, the Discounted Cash Flow Appraisal Method attempts to use past performance to project the free cash flow in the future. Generally, sellers and buyers agree on projected future earnings 5 years into the future. Then a discount is applied to the future cash flows in years 2-5 to determine their net present value. By adding up the net present values of future earnings, a valuation is determined. Of course, the discount applied to the future cash flows is a subjective number and is broadly based on risk factors.
Does the Discounted Cash Flow Appraisal Method apply to your business or to your acquisi forget to sign up for our free daily email delivery so you can get future inspirational blog posts deliver directly to your email each morning?
