6. DCF Flashcards
What is a DCF?
- A growth explicit investent method of valuation
- A form of income approach valuation
- A valuation model that seeks to determine the value of a property by examining its future net income or porjected cash flow from the property and then discounting the cash flow to arrive at an estimate current value of the property
What are some example of valuations where projected cash flows are explicitly estimated over a finite period?
The approach separates out and explicitly identifies growth assumptions rather than incorporating them within an ARY.
- Short leasehold interest and properties with income voids or complex tenures
- Phased development projects
- Over rented properties
Explain the simple methodology of a DCF
Estimate the cash flow (income less expenditure) for an agreed holding period
Estimate the exit value at the end of the holding period
Select the discount rate (IRR)
Discount cash flow at discount rate
Value is the sum of the completed DCF to provide the NPV
What is NVP?
Net present value
Can be used to determine if an investment gives a positive return against a target rate of return
Positive NPV = Exceeded investors target
Negative NPV = Not achieved investors target
What is IRR?
Internal rate of return
The rate of return at which all future cash flows must be discounted to produce a NPV of zero
Used to assess the total return from an investment opportunity making some assumptions regarding rental growth, re-letting and exit assumptions
How can IRR be calculated if the valuer does not have a software programme?
1) Input current market value as a negative cash flow
2) Input projected rents over holding period as a positive value
3) input projected exit value at teh end of the term assumed as a positive value
4) Discount rate (IRR) is the rate chosen which provides a NPV of zero
5) If NPV is more than zero, then the target rate of return is met
Is there any RICS documents surrounding DCF?
Yes - Practice Information: Discounted cash flow valuations, Nov 23
It covers topics to include:
* Explicit DCF versus the implicit method of valuation
* The context for appling explicit DCF methods
* Differences between the inputs for market value and investment value
