Discounted Cash Flow (DCF) Method or Time Adjusted Technique
The discounted cash flow technique is an improvement on the pay-back period method. It takes into account both the interest factor as well as the return after the pay-back period. The method involves three stages.
i. Calculation of cash flows, i.e., both inflows and outflows (preferably after tax) over the full life of the asset.
ii. Discounting the cash flows so calculated by a discount factor
iii. Aggregating of discounted cash inflows and comparing the total with the discounted cash outflows.
iv. Discounted cash flow technique thus recognizes that Re 1 of today (the cash outflow) is worth more than Re. 1 received at a future date (cash inflow)
Discounted cash flow methods for evaluating capital investment proposals are of three types:
(a) Net Present Value (NPV) Method
(b) Excess Present value Index (or) Benefit Cost Ratio
(c) Internal Rate of Return
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