Discounted Cash Flow (DCF)

1
Discounted Cash Flow (DCF)

• Dr. Jim Burton
• Marketing Real Estate
• Richards College of Business

2
Overview

• Uses
• Forecasting
• Discounting Process
• Investment Analysis
• Net Present Value (NPV)
• IRR

3
Uses

• PV cash flows
• Extract discount rate

4
Forecasting

• Rents vacancies
• Operating expenses
• Net operating income (NOI)
• Reversion/selling price
• Discount rate
• Terminal cap rate

5
Discounting Process

• Initial cost or investment
• Periodic cash flows
• Reversion or sale proceeds
• Yield or discount rate (IRR)
• Example, p.572.

6
Investment Analysis

• Net Present Value (NPV)
• IRR
• Payback period
• Profitability index
• Time-weighted rate

7
Net Present Value (NPV)

• IRR0
• PV cash flows at target rate
• Subtract original equity
• If NPVgt1, Buy
• If NPVlt1, Do Not Buy

8
IRR

• Good for comparing normal income properties
• Limitations
• Multiple IRRs
• Reinvestment

9
Others

• Paybackequity/annual CF
• Profitability indexPV CF/equity
• Time-weighted rate average of all rates over
  time used to measure portfolio manger
  performance, not portfolio performance.
• Office example, p. 590.