What does a DCF valuation calculate?

• A. The present value of future cash flows
• B. The current market price
• C. The historical earnings
• D. The replacement cost

Answer: (A)

A DCF valuation calculates the present value of expected future cash flows. By projecting the cash the asset is expected to generate over time and discounting those amounts back at an appropriate rate that reflects time value and risk (often the cost of capital), you convert future dollars into today’s value. Summing these discounted cash flows yields the intrinsic value of the asset. Terminal value is often included to capture cash flows beyond the explicit forecast period, and the result can be adjusted to reflect debt and other financial items to arrive at enterprise or equity value.

Why the other ideas don’t fit: the current market price is just what the market is willing to pay now, not the value implied by future cash generation; historical earnings look backward, not at future cash flow potential; replacement cost is about how much it would cost to recreate the asset, not the value of the ongoing business.