Editing Discounted cash flow (section)

==Methods of appraisal of a company or project==
For these [[Valuation (finance)|valuation]] purposes, a number of different DCF methods are distinguished today, some of which are outlined below. The details are likely to vary depending on the [[capital structure]] of the company. However the assumptions used in the appraisal (especially the equity discount rate and the [[cash flow forecast|projection of the cash flows]] to be achieved) are likely to be at least as important as the precise model used.  Both the income stream selected and the associated [[cost of capital]] model determine the valuation result obtained with each method. (This is one reason these valuation methods are formally referred to as the Discounted Future Economic Income methods.) 
The below is offered as a high-level treatment; for the components / steps of business modeling here, see {{slink|Outline of finance|Financial modeling}}.

===Equity-approach===
* [[Flows to equity]] approach (FTE)
**Discount the cash flows available to the holders of equity capital, after allowing for cost of servicing debt capital
**Advantages: Makes explicit allowance for the cost of debt capital
**Disadvantages: Requires judgement on choice of discount rate

===Entity-approach===
* [[Adjusted present value]] approach (APV)
** Discount the cash flows before allowing for the debt capital (but allowing for the tax relief obtained on the debt capital)
** Advantages: Simpler to apply if a specific project is being valued which does not have earmarked debt capital finance
** Disadvantages: Requires judgement on choice of discount rate; no explicit allowance for cost of debt capital, which may be much higher than a [[risk-free rate]]
* [[Weighted average cost of capital]] approach (WACC)
** Derive a weighted cost of the capital obtained from the various sources and use that discount rate to discount the unlevered free cash flows from the project
** Advantages: Overcomes the requirement for debt capital finance to be earmarked to particular projects
** Disadvantages: Care must be exercised in the selection of the appropriate income stream. The net cash flow to total invested capital is the generally accepted choice.
* [[Total cash flow]] approach (TCF){{Clarify|date=February 2009}}
** This distinction illustrates that the Discounted Cash Flow method can be used to determine the value of various business ownership interests. These can include equity or debt holders.
** Alternatively, the method can be used to value the company based on the value of total invested capital. In each case, the differences lie in the choice of the income stream and discount rate. For example, the net cash flow to total invested capital and WACC are appropriate when valuing a company based on the market value of all invested capital.<ref>{{cite book
  | last = Pratt | first = Shannon |author2=Robert F. Reilly|author3=Robert P. Schweihs  | title = Valuing a Business | publisher = McGraw Hill | series = McGraw-Hill Professional  | year = 2000  | url = https://books.google.com/books?id=WO6wd8O8dsUC&q=shannon+pratt  | isbn = 0-07-135615-0 }}
</ref>