The time value of money is a basic fundamental of finance. The underlying principle is that a dollar presently in possession is worth more than a dollar received in the future owing to its earning potential. The money today can be invested which has the possibility of growing into more money in the future. Building on this premise when researching a company’s potential, it would be beneficial to know the present value of said company. The discounted cash flow (DCF) analysis can assist with this calculation. The DCF “analysis uses future free cash flow (FCF) projections and discounts them to estimate the present value, which is then used to evaluate the investment potential.” This essentially endeavors to assess a company based on its projected future value. The FCF is not specifically stated in any one financial statement. Instead, it can be calculated by using both the income statement and balance sheet. This will provide the cash flow from operating activities (CFO) and can be computed by adding the Net Income, Depreciation, Amortization and Non-cash Income then subtracting the Net Working Capital (NWC is essentially the current assets minus the current liabilities). In the case of Home Depot as …show more content…
The DCF is one such tool as it takes into consideration the time value of money. Since DCF makes some assumptions in its calculations there are certain risks involved. “Even a small change in a single assumption can result in very different valuation results.” As a result, if the risk increases the present value decreases. The decline of the present value and higher risk associated with the company will have investors wanting a greater rate of return to compensate for the elevated risk. Conversely, a decrease in risk for the company will increase the present value. Investors in this case would encounter a lower rate of return since the risk is