What are the two main components of a Discounted Cash Flow (DCF) analysis?

In a Discounted Cash Flow (DCF) analysis, the two primary components are the projection period and the terminal value. The projection period involves forecasting the cash flows that a company is expected to generate over a specific timeframe, typically ranging from 5 to 10 years. These projections are fundamental, as they are based on the company's anticipated revenues, expenses, and growth rates. The resulting cash flows during this period are then discounted back to their present value using a suitable discount rate, which reflects the risk associated with those cash flows.

The terminal value, on the other hand, accounts for the cash flows beyond the projection period. This component is essential because it estimates the value of the company at the end of the projection period, capturing the continuing value of the business indefinitely. It can be calculated using various methods, such as the perpetuity growth model or exit multiple method, and is also discounted back to the present value.

Together, the projection period and terminal value encompass the total value derived from future cash flows in a DCF analysis, making them critical elements in determining the present worth of an investment.