Corporate Fin Mgt NDLM.PDF

Learning Unit 2

Reading Material

Discounted Cash Flow Technique

1. The objective of the application of DCFT is to enable the investor to take
   economical decisions i.e., decision with the least investment for the highest returns.

1.1. DCFT is based upon the concept of time value of money. In other words,

money in hand today is more valuable than the same amount of money after

some time, because of the existence of cost of money in terms of interest.

1.2. DCFT technique is useful in the following areas of investment decisions.

• Buying or hiring.


• Expanding the existing plant/ business/ or to going in for a new plant/
  business.


• Whether to make full cash down payment or to make payments in
  installments.


• Whether to opt for machinery operated work or labour oriented work


• Determine lead time in inventory management.


• Project investments and return on such investments.

1.3. To apply DCFT, a common point of time should be determined, especially in

project finance. For example, cash out flow estimation may be made on

different dates six times during a calendar year. Similarly returns may be

obtained on different dates in the same year. All such estimated cash out flows

and cash in flows at different points of time in the year, must be brought in line

with a common time unit for the application of DCFT. The common unit of time

say, one year or 6 months or 3 months must be determined by the Project Board

for uniformity and consistency in calculation. Application of DCFT can also help

in comparing one project estimation with other projects, in order to facilitate the

investor in the selection of a project for implementation. DCFT can be used to

select the most economical method for application.

1.4 In project finance, DCFT is the most scientific technique to measure benefits and
costs associated with project.

1.5 DCFT will help assess the present value of returns and cost. This is based on the
reverse of Compound Interest formula. The compound interest formula is FV =
PV X (l + r)n^

Where FV stands for Future Value,

PV stands for Present Value,