Here are some notes on discounted and non-discounted cash flow methods for investment appraisal in detail:
- Discounted cash flow (DCF) methods are methods that calculate the present value of future cash flows. The present value is the value of an asset or investment today, based on the expected future cash flows from the asset or investment. DCF methods are used to assess the value of an investment and to determine whether or not the investment is worth undertaking.
- Non-discounted cash flow methods are methods that do not calculate the present value of future cash flows. Instead, these methods simply add up the future cash flows from an investment and then compare the total to the initial investment cost. Non-discounted cash flow methods are often used for simple investments or for investments where the future cash flows are difficult to predict.
Here are some of the most common DCF methods:
- Net present value (NPV): NPV is the most common DCF method. It calculates the present value of the future cash flows from an investment and then subtracts the initial investment cost. If the NPV is positive, the investment is considered to be worthwhile.
- Internal rate of return (IRR): IRR is the discount rate that makes the NPV of an investment equal to zero. The IRR is the rate of return that an investment is expected to generate.
- Payback period: The payback period is the amount of time it takes for an investment to generate enough cash flow to repay its initial investment cost. The payback period is a simple way to assess the liquidity of an investment.
Here are some of the most common non-discounted cash flow methods:
- Payback period: The payback period is a simple way to assess the liquidity of an investment.
- Return on investment (ROI): ROI is the ratio of the net profit from an investment to the initial investment cost. ROI is a simple way to assess the profitability of an investment.
- Return on assets (ROA): ROA is the ratio of the net profit from an investment to the total assets of the company. ROA is a measure of how efficiently a company is using its assets.
The choice of DCF or non-discounted cash flow methods depends on the specific investment and the needs of the decision-maker. DCF methods are more sophisticated and can provide more accurate estimates of the value of an investment. However, they can also be more complex and time-consuming to use. Non-discounted cash flow methods are simpler to use and can provide a quick assessment of the value of an investment. However, they may not provide as accurate an estimate of the value of an investment as DCF methods.