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•Six Greatest Financial Necessities of Business Life 71
In particular, consider the discount factor used above for year three, i.e. 0.751. When
deciding how much we could borrow from the bank in respect of Aunt Mary’s be-
quest we divided £10,000 by 1.331. An exactly equivalent calculation is performed
by multiplying £10,000 by 0.751 – the discount factor for three years at 10%.
The final result takes into account all cashflows and is known as the net present
value of the project.
If compelled to choose between two projects, we will select the one with the
higher net present value. If we have a large number of projects that can all be under-
taken, then we should invest in every project that has a positive net present value.
In effect the discounting factor brings the value of each number into today’s
money, present value, thus ensuring that you are comparing pounds now
with pounds to be earned or spent in the future. The discounted
cashflow and
net present
What can you use DCF for? value earns its
place in the
The discounted cashflow and net present value earns its place in the 100 100 greatest
greatest business ideas by its simple ability to put the logical case behind business ideas
dilemmas or decisions. Other methods, such as payback or average rate of by its simple
return, all run dangers that a decision that looks good using that method ability to put
of appraisal will turn out to be a disaster. the logical
As well as in a business environment, DCF has a role in any individual’s case behind
financial plan. Here are some ways that you can use it in your personal dilemmas or
financial life. decisions.
• You can solve the problem of rent or buy. While the UK Government gave tax
relief on mortgage repayments it tended to be a relatively straightforward deci-
sion to buy the home you live in rather than rent it. This has become less
certain as the tax benefit has gone and it is theoretically worth making a com-
parison to check that financially it remains the thing to do.
