Discounted Cash Flow (DCF) Flashcards
1
Q
Tell me about discounted cash flow and when they are generally used
A
- Growth implicit investment valuation approach
- Involves projecting estimated cash flows over an assumed holding period plus an exit value at the end of that period, usually arrived at on a conventional ARY basis. The cash flow is then discounted back to the present day at a discount rate (IRR/TRR) that perceived the investors targets and perceived level of risks
- Used for some alternative investments – income strips
- Short leasehold interests and properties with complex tenure or voids
- Nonstandard investments i.e. rent review patterns
- Phased development projects
2
Q
What is the simple methodology of a DCF valuation?
A
- Estimate the cash flow – income, expenditure, the price you pay the for the property as a negative outflow
- Estimate the exit value at the end of the holding period
- Select the discount rate
- Discount the cash flow at the discount rate
- Value is the sum of the completed discounted cash flow to provide the NPV
3
Q
What is the Net Present Value and how can it be interpreted?
A
- The NPV is the sum of the discounted cash flows of a project
- Used to determine if an investment gives a positive return against a target rate of return
- NPV = positive – investment has exceeded the investors target rate of return
- When NPV is negative it has not achieved the target rate of return
4
Q
What is the IRR and how can it be interpreted?
A
- The rate of return at which all future cash flows must be discounted to produce an NPV of zero
- The IRR is used to assess the total return from an investment opportunity making some assumptions regarding rental growth, re-letting and exit assumptions
- If the valuer does not have a software programme to calculate the IRR, then linear interpolation can be used to estimate the IRR
5
Q
How do you calculate IRR?
A
- Input current market value as a negative cash flow
- Input projected rents over holding period as a positive value
- Input projected exit value at the end of the term assumed as a positive
- Discount rate (IRR) is the rate chosen which provides an NPV of zero.