What are DCF and WACC? Well a DCF takes a cash flow occurring in the future and calculates how much would be paid for it today So it's an important valuation technique Let's have a look at an example Imagine investing 100 today and you require a 10% return Well at time period 0, your cash flow out from you is 100 And that 10% return means that your investment is going to have to grow So we're going to have to multiply that 100 by one plus 10% or 1.1 That means that at time period 1 i.e. one year from today Our investment will be worth 110 Then another year on after another 10% it will be worth 121 And then at the end of year 3 at the end of this project it will be worth 133.1 And that means your cash flow will be paid out to you and you will have received three years worth of a 10% return Great But what if it happens in reverse? You are offered 133.1 in three years time, and you require a 10% return How much should you pay now? Well you have to start at year 3 You have to imagine the cash flows coming to you, 133.1. But that has to represent three years worth of 10% return So how do I get back to the amount that I should invest today? Well I need to divide by one plus my required return or divide by 1.1 in this example So that means by year 2, it's discounted to 121 By year 1 it's discounted to 110 And by year 0 (time period 0) it's 100 And that's how much I would pay now in order to secure a cash flow of 133.1 in three years time Assuming I require a 10% retur Now that 100 represents the present value of a 133.1 future cash flow And that's what a DCF means or a discounted cash flow, taking future cash flows and present valuing them or discounted them to today Now the investor's 10% required return also represents a cost of capital of 10% for the company being invested in Of course you're getting a 10% return to you but the company is having to pay out this extra money It's a cost to them and we call that a 'cost of capital' When the company sources cash from a variety of places, so maybe an equity investment but also they borrowed from a bank Well then a weighted average cost of capital or WACC is calculated And that WACC is the average cost of the capital to the company or the average required return from the investors