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The discounted cash flow (DCF) is a method of company valuation, usually used for late-stage startups. It is mostly applied by investors to check whether their investment will bring substantial profit.

The principle of the discounted cash flow is very similar to the Net Present Value (NPV). The calculation consists of a few steps:

• First of all, you have to project cash flows for the next couple of years. It is usually done by estimating the growth rate of the company – for example, you assume that each year will bring a 15% increase in the company value.
• In the second step, the cash flow estimates are discounted using an annual discount rate. This calculation reflects the change in the value of your money. Consider this example: $100 today is not an equivalent of $100 in three years from now – after all, you could put it in a savings account, where its value would steadily increase. The discount rate is usually assumed to be equal to WACC (Weighted Average Cost of Capital).
• In the next step, you need to estimate the terminal value of your company. Usually, you won’t assume that your startup grows at a steady rate for infinity. Instead, you have to assume a lower growth rate, called the terminal growth rate, to show that growth is slowing down. Basing on that number, you will estimate the increase in your company’s value from the end of the growth phase to the end of the startup’s existence.
• Finally, the result (called the total intrinsic value) has to be compared with the amount of money you want to invest. If the intrinsic value is higher, it means that the returns from the investment exceed the costs. If, on the other hand, the intrinsic value is lower, the investment will (most likely) never pay off.