DCF (Discounted Cash Flow) is the gold standard of valuation methods in finance. It calculates what a business, project, or investment is worth today based on the cash it is expected to generate in the future — adjusted for the fact that a dollar today is worth more than a dollar tomorrow.
The formula: DCF = CF1/(1+r)^1 + CF2/(1+r)^2 + ... + CFn/(1+r)^n, where CF = cash flow and r = discount rate. Example: A project expected to generate $100,000/year for 5 years at a 10% discount rate has a DCF value of about $379,000 — not $500,000, because future cash is worth less today.
Investment bankers, private equity firms, and analysts use DCF models to value companies in M&A deals, IPO pricing, and stock analysis. The biggest challenge: small changes in assumptions (growth rate, discount rate) can dramatically change the valuation. As Warren Buffett noted, DCF is the only logical way to value a business.