In helping us answer the question, "what is a discounted cash flow?" We start off by looking at the EV equity bridge Here we can see that if we took EV minus net debt, we'd get to equity Or alternatively if I wanted to get to EV, I could take equity plus net debt equals EV The first one to look at here, EV minus debt equals equity How do you actually calculate that EV or enterprise value? Well we could use multiples, such things as trading comps. Or we could use a discounted cash flow (a DCF) The enterprise value represents the net operating assets of a business. And by doing a discounted cash flow we will thus workout the value of that enterprise value, of those net operating assets So we normally short hand it, it's normally called a DCF And it takes a cash flow forecast and discounts that to todays value So if I was to ask you, do you want 100 of money now or 100 in a years time And if I then said why? Why do you want the money now? You could say, well I could invest it. And that 100 could be 105 in a year's time So I would much rather have the money now. Also there's inflation, which would reduce my purchasing power over that year And there's risk, there's risk that I might not get the money in a years time So for a variety of reasons, we prefer money now. Money now has greater value What we do in a discounted cash flow, is we take the cash flows for many years into the future and discount them back to today Find out what the value of all of those cash flows today might be Now it is an intrinsic, not a relative valuation tool A relative valuation tool says, we look out towards similar companies, see what they're worth Find out some ratios in them and then apply them to our company Not with the discounted cash flows. A discounted cash flow says I want to find out the revenues of my company The costs, all of its cash flows! Find the cost of this company's finance and then I find the value of this company. Very much looking internally And lastly, it's the modellers view of value So again, not looking externally towards other companies I'm going to model my value for this company Now there are good things and bad things about a discounted cash flow The first good thing, it gives an absolute value So if I took three payments for the next three years, maybe 105, 110 and 115 and I discounted them back to today I might get a present value of 300, and that is an absolute value Next up, it requires detailed modelling and we can get to know the company and what drives the company quite well And thirdly, it focuses on cash. At the end of the day it's cash that we give as a return to our shareholders and our debtholders What are the negatives of discounted cash flows? Well it does require significant expertise to build one And it's very sensitive to its assumptions If we looked at those cash flows going forward and I just changed the growth of those cash flows by maybe a percent or two That would dramatically change the value of the company However the positives do tend to out weight the negatives and we find it a very valuable tool for valuing a company