In finance, discounted cash flow (DCF) analysis is a method of valuing a security, project, company, or asset using the concepts of the time value of money. Discounted cash flow analysis is widely used in investment finance, real estate development, corporate financial management and patent valuation. It was used in industry as early as the 1700s or 1800s, widely discussed in financial economics in the 1960s, and became widely used in U.S. courts in the 1980s and 1990s.
Discounting is a financial mechanism in which a debtor obtains the right to delay payments to a creditor, for a defined period of time, in exchange for a charge or fee. Essentially, the party that owes money in the present purchases the right to delay the payment until some future date. This transaction is based on the fact that most people prefer current interest to delayed interest because of mortality effects, impatience effects, and salience effects. The discount, or charge, is the difference between the original amount owed in the present and the amount that has to be paid in the future to settle the debt.
In finance, the net present value (NPV) or net present worth (NPW) applies to a series of cash flows occurring at different times. The present value of a cash flow depends on the interval of time between now and the cash flow. It also depends on the discount rate. NPV accounts for the time value of money. It provides a method for evaluating and comparing capital projects or financial products with cash flows spread over time, as in loans, investments, payouts from insurance contracts plus many other applications.
Internal rate of return (IRR) is a method of calculating an investment’s rate of return. The term internal refers to the fact that the calculation excludes external factors, such as the risk-free rate, inflation, the cost of capital, or financial risk.
In economics and finance, present value (PV), also known as present discounted value, is the value of an expected income stream determined as of the date of valuation. The present value is usually less than the future value because money has interest-earning potential, a characteristic referred to as the time value of money, except during times of zero- or negative interest rates, when the present value will be equal or more than the future value. Time value can be described with the simplified phrase, "A dollar today is worth more than a dollar tomorrow". Here, 'worth more' means that its value is greater. A dollar today is worth more than a dollar tomorrow because the dollar can be invested and earn a day's worth of interest, making the total accumulate to a value more than a dollar by tomorrow. Interest can be compared to rent. Just as rent is paid to a landlord by a tenant without the ownership of the asset being transferred, interest is paid to a lender by a borrower who gains access to the money for a time before paying it back. By letting the borrower have access to the money, the lender has sacrificed the exchange value of this money, and is compensated for it in the form of interest. The initial amount of the borrowed funds is less than the total amount of money paid to the lender.
An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed. The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, the compounding frequency, and the length of time over which it is lent, deposited, or borrowed.
Expenditure is an outflow of money, or any form of fortune in general, to another person or group to pay for an item or service, or for a category of costs. For a tenant, rent is an expense. For students or parents, tuition is an expense. Buying food, clothing, furniture or an automobile is often referred to as an expense. An expense is a cost that is "paid" or "remitted", usually in exchange for something of value. Something that seems to cost a great deal is "expensive". Something that seems to cost little is "inexpensive". "Expenses of the table" are expenses of dining, refreshments, a feast, etc.
Cost of goods sold (COGS) is the carrying value of goods sold during a particular period.
A swap, in finance, is an agreement between two counterparties to exchange financial instruments or cashflows or payments for a certain time. The instruments can be almost anything but most swaps involve cash based on a notional principal amount.
A certificate of deposit (CD) is a time deposit, a financial product commonly sold by banks, thrift institutions, and credit unions. CDs differ from savings accounts in that the CD has a specific, fixed term and usually, a fixed interest rate. The bank expects CD to be held until maturity, at which time they can be withdrawn and interest paid.
Fixed investment in economics is the purchasing of newly produced fixed capital. It is measured as a flow variable – that is, as an amount per unit of time.
A structured product, also known as a market-linked investment, is a pre-packaged structured finance investment strategy based on a single security, a basket of securities, options, indices, commodities, debt issuance or foreign currencies, and to a lesser extent, derivatives.
Business valuation is a process and a set of procedures used to estimate the economic value of an owner's interest in a business. Valuation is used by financial market participants to determine the price they are willing to pay or receive to effect a sale of a business. In addition to estimating the selling price of a business, the same valuation tools are often used by business appraisers to resolve disputes related to estate and gift taxation, divorce litigation, allocate business purchase price among business assets, establish a formula for estimating the value of partners' ownership interest for buy-sell agreements, and many other business and legal purposes such as in shareholders deadlock, divorce litigation and estate contest. In some cases, the court would appoint a forensic accountant as the joint expert doing the business valuation. In these cases, attorneys should always be prepared to have their expert’s report withstand the scrutiny of cross-examination and criticism.
Capital budgeting, and investment appraisal, is the planning process used to determine whether an organization's long term investments such as new machinery, replacement of machinery, new plants, new products, and research development projects are worth the funding of cash through the firm's capitalization structure. It is the process of allocating resources for major capital, or investment, expenditures. One of the primary goals of capital budgeting investments is to increase the value of the firm to the shareholders.
Shortest job next (SJN), also known as shortest job first (SJF) or shortest process next (SPN), is a scheduling policy that selects for execution the waiting process with the smallest execution time. SJN is a non-preemptive algorithm. Shortest remaining time is a preemptive variant of SJN.
In finance, return is a profit on an investment. It comprises any change in value of the investment, and/or cash flows which the investor receives from that investment, such as interest payments, coupons, cash dividends, stock dividends or the payoff from a derivative or structured product. It may be measured either in absolute terms or as a percentage of the amount invested. The latter is also called the holding period return.
The following outline is provided as an overview of and topical guide to finance:
Loss reserving refers to the calculation of the required reserves for a tranche of general insurance business. It includes outstanding claims reserves.
The credit channel mechanism of monetary policy describes the theory that a central bank's policy changes affect the amount of credit that banks issue to firms and consumers for purchases, which in turn affects the real economy.
This glossary of economics is a list of definitions of terms and concepts used in economics, its sub-disciplines, and related fields.
