Discounted Cash-Flow

Discounted cash flow ( DCF) (Eng. discounted cash flow ) describes a method of calculating the value, especially for business valuation and to determine the market value of real estate. It builds on the mathematical concept of discounting ( eng. discounting ) of future cash flows ( cash flow eng. ) to determine the net present value.

Overview

The discounted cash flow method ( DCF) are methods for valuing companies, entire projects or subprojects. As a method of business valuation they belong to the field of finance and accounting (business ). Important applications are found in the assessment of lease-contract arrangements with Over Under Rent or Rent.

Description of each procedure

The DCF method is based on the value determined in the context of a corporate planning future payment surpluses (including cash flow, cash flow ) and discounting them with the help of capital costs on the valuation date. In this case (eg corporation tax or income tax) are included in the assessment for taxes payable. The so- determined cash value or net present value is the discounted cash flow. Typically, the future cash flows are divided into two phases: the first phase lasts 5-15 years, in the second phase, either one separately to be determined residual value or a perpetuity is assumed. The capital costs are determined in practice very often with the aid of a capital market model (CAPM). The resulting by the tax deductibility financing effect is mapped differently in the various DCF method.

Questions arise when the DCF procedure basically three problems:

  • The determination of the estimates for the future periodic cash flows.
  • The inclusion of taxes (corporation tax or income tax).
  • The determination of the discount rate to be used to discount the periodic cash flows.

Depending on financing assumptions different DCF methods are now distinguished, which can lead to various corporate values ​​(but not always have to). Currently, an inclusion of a corporate four methods can be distinguished:

  • APV approach (Adjusted Present Value )
  • WACC ( Weighted Average Cost of Capital)
  • TCF approach (Total Cash Flows )

Depending on the chosen method and the assumed financing policy there is a Zirkularitätsproblem. It is often difficult to determine in practice, the extent to which the assumptions of the DCF theory are met. In particular, the forecast of cash flows and the choice of discount rates turn out as levers that can sometimes give the impression of a manipulation of desired results.

Business Valuation

Austria to KFS BW 1

In Austria, the expert opinion KFS BW 1, published by the Chamber of Auditors, relevant. The discounted cash flow method is described to determine the value of the company through capitalization (calculation of the net present value ) of cash flows.

Because different equity and debt in the cost, in capitalization different capital costs have to be considered ( interest rates). To determine the cost of equity, the CAPM is usually applied. The considered cash flows are defined differently depending on the procedure.

Of the gross method (Entity - method) of the WACC and the APV approach will apply, in addition also the net method ( equity method ).

  • In the WACC concept of market value of total capital is determined by capitalization of free cash flows with the weighted average cost of capital ( WACC).
  • In APV concept of complete self is assumed in the first step, to determine, under this assumption, the market value of the company. This is again done by capitalization of free cash flow, but at cost of equity. After taking into account the tax savings from the tax shield of the market value of the debt is taken off and it remains the market value of equity.
  • The net method, the net inflows to the company owners are capitalized to cost of equity. This corresponds to the income approach with consideration of the risk.

Both the income approach and as well as the DCF methods are based on the same conceptual basis: The enterprise value is determined as the present value of future financial surpluses. These methods result in identical assumptions to identical results.

Germany IDW S1

In Germany the company valuation IDW S1 standard for determining the enterprise value is applied.

Property Valuation

The discounted cash flow method is the basis for a capitalization of future cash inflows and outflows, and is therefore ultimately a determination of present value of future projected nominal net proceeds.

The DCF is divided in this context in several phases with different forecast quality, as the future real estate related income are increasingly uncertain with increasing time horizon. An explicit forecast is thus rarely over the entire remaining useful life of a property. In a first phase, the cash flow is always out in detail in its expected development. Most of the forecast period is 10, sometimes 5, 15 or 20 years. The choice of the time horizon is, inter alia, depending on the intended retention period of the forecast data available. Basis of the first detailed forecast phase, for example, the contractual rents, expected re-letting and necessary repairs or upgrades. A subsequent, not always modeled phase then operates with average payments and average growth rates, that is no longer displayed meaningful identifiable or economically insignificant details from. The last phase finally summarizes all the subsequent developments on the residual value of the property together. The residual value can be understood as the final payment for the purposes of the sale proceeds. Based on this assumption, for example, a simple income multiplier or a further return calculation.

The DCF method is often used in the international valuation measuring the fair value of such objects that are traded in the ordinary course of business under investment analytical aspects. In general, these are more complex, let properties such as Office buildings and shopping centers. One advantage of the discounted cash flow method is the comparability of different investments with each other. Furthermore, it is in particular the case of objects with time- varying revenue streams, such Einmieterobjekten, where re- letting and modernization scenarios to be mapped, a comfortable applicable instrument. The DCF is internationally not the dominant valuation method, however, a widely used valuation tool. It is recognized by both the European ( TEGoVA ), UK (RICS ) and international ( IVSC ) Contributor associations, as well as potential earnings method after ImmoWertV (§ 17).

A weakness of the DCF in the determination of the market value ( market value) of property is the lack of generally accepted rules of procedure ( such as the WertV ), which can be used in the determination of market value. This applies to the approach of capitalization and discount rate as well as the predictions themselves during eg uses the income approach for the capitalization of income property yields, which are reported to the public in real estate market reports of expert committees, the approach of capitalization and discount rate of DCF method relies heavily on the judgment of the user of the procedure. The Society of Property Researchers (gif), however, has recently guidelines for standardizing the DCF method published which attempt to limit this weakness of the DCF. Nevertheless, there is a lack of current, near-market sources for the underlying computational variables which could use for creating and objective proof of his opinion of the reviewer.

The simplified DCF method ( hardcore -layer and term reversion ) off while not on period sharp presentation of receipts and payments, but operate with liquidated inventory and market rents; depending on the ratio of market rent, an object can be over-rented or under-rented.

It should be noted in the application of DCF analysis, that for the period under consideration a discount rate is to be selected, which is different from the property interest and no implicit index increases, including ( so-called equated yield ), whereas the final value (terminal value ) as an interest, including any index increases ( equivalent yield ) must be selected.

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