Discounted cash flow definition

Discounted cash flow is the net present value of a future stream of cash that is calculated using a formula (net present value) that reduces the future value by the cost of money or estimated inflation.

The discounted cash flow formula is available in most spread sheet programs and any good financial calculator. So, don't worry about doing the math. The key is that the present value of a future flow of cash is less than 100% when the cost of capital over time is included.

However, here is an example that should help explain: If you are expecting to bring in $100 in cash in each of the next two years but the inflation rate is anticipated to be 3%, that $100 is worth 3% less or $97 (($100 X (1-0.03)). At the end of year two, the new $100 is worth even less because it loses 3% for two years - $94 ((($100 X (1-0.03)) X (1-0.03))). Adding the two years gives a total value of $191 after discounting for inflation.