Further to the Basic tutorial on DCF analysis with example - in this article I will highlight some more practicle uses of DCF analysis, by varying the investment returns and time horizon and how it impacts your investments.
Here is the original investment plan as covered in the Basic tutorial on DCF analysis with example:
| Start Date | 01-Jan-05 | Investment Period | 3 years | | | |
| End Date | 31-Dec-07 | Interest Rate | 9% | Present Value of | ||
| A | B | C | D | E | F | G |
| Date | Stock | Buy | Sold | Annualized time | PV-Buy | PV-Sold |
| 01-Jan-05 | Microsoft | (1,000.00) | | - | (1,000.00) | - |
| 03-Mar-05 | GS | (200.00) | | 0.17 | (197.14) | - |
| 01-Dec-05 | Google | (4,000.00) | | 0.92 | (3,696.68) | - |
| 10-Feb-06 | Microsoft | | 1,200.00 | 1.11 | - | 1,090.57 |
| 11-Jul-06 | Exxon | (5,000.00) | | 1.52 | (4,384.89) | - |
| 13-Sep-06 | Amazon | (2,000.00) | | 1.70 | (1,727.65) | - |
| 19-Sep-06 | AMX | (3,000.00) | | 1.72 | (2,587.81) | - |
| 28-Dec-06 | GS | | 600.00 | 1.99 | - | 505.49 |
| 05-Jan-07 | AMX | | 3,600.00 | 2.01 | - | 3,027.19 |
| 09-Jun-07 | Google | (5,000.00) | | 2.44 | (4,053.34) | - |
| 10-Oct-07 | Google | | 12,000.00 | 2.77 | - | 9,449.58 |
| 11-Oct-07 | Exxon | | 5,500.00 | 2.78 | - | 4,330.03 |
| 31-Dec-07 | Amazon | | 2,100.00 | 3.00 | - | 1,621.97 |
| | | | | | | |
| Total | | (20,200.00) | 25,000.00 | | (17,647.52) | 20,024.82 |
| Net (Sold-Buy) | | | 4,800.00 | | | 2,377.31 |
| Net % Return | | | 23.76% | | | 13.47% |
| Annualized % Return | | 7.37% | | | 4.30% | |
As we can observe, the Net % return is positive, since ALL the investments are considered to the positive (as displayed in the table below):
| | Buy | Sell | % Profit |
| Microsoft | -1000 | 1200 | 20.00% |
| GS | -200 | 600 | 200.00% |
| Google | -9000 | 12000 | 33.33% |
| Exxon | -5000 | 5500 | 10.00% |
| AMX | -3000 | 3600 | 20.00% |
| Amazon | -2000 | 2100 | 5.00% |
| TOTAL | -20200 | 25000 | 23.76% |
5 comments:
Nice article. Your PV seems to be little off. Can you tell me what did u consider to get those numbers.
I got your way of calculating the PV but i'm not too sure if DCF is the right way to calculate the absolute profits as well.
Here is my argument (might be total nonsense .. but let me write it.. )
1. You are calculating your profits wrt 1-Jan-2005.
2. From what i understand DCF is a methodology that is used to discount future cash flows. (using estimates)
3. Now that these buy-sell events have already occurred in the past is DCF the right approach? Is it correct to analyze the profit/loss of the past events using DCF?
Let me know if these make any sense at all !!
--Praveen
Hi Praveen,
It's not just about future cash flows.
It is true that the word "DISCOUNT" is used to get the PV of future cash flows.
But the concept is more to take care of the time value of money.
There is no hard and fast rule that DCF should be used only for future cash flows.
May be I shouldn't have used the term DCF, because here we are considering past cashflows - but even while analyzing the past investments, you need to use the same concept - which in essence leads to the same calculations and numbers.
You mentioned that the "PV seems to be little off. Can you tell me what did u consider to get those numbers.".
As far as I understand, all the details are there in the table.
Let me know what you are unable to understand.
Thanks,
Hey,
Its nice reading your stuff.. Refreshing my old text books to get things right :)
The PV understanding was an err from my side. sorry for that..
Let me tell you my understanding
All your investments are Valued on 1-Jan-2005.
If I knew/estimated the future profits/losses for your investment period of 4 years on 1-Jan-2005 you could have come to a conclusion saying that your net profit is 4.30% Per Year.
But since you are analyzing this data say on 1-Jan-2008 the number 2377.31 in Net (Sold-Buy) row.. how much sense does this # make on 1-Jan-2008.
Does this make any sense ??
It only makes sense to the extent where you place your reference point.
Let me elaborate this more:
I am writing article to compare stock market invetment returns w.r.t. the bank account or risk free bonds.
For a savings bank account or Fixed deposit - you know the % interest (or return) you'll earn before hand - i.e. at the begining of the investment. So your reference point is at the begining of investment period. Since I'm comparing the stock investment with risk free bank returns, that's the reason I've taken 1-Jan-2005 as the ref point instead of 2007 or 2008. Had I taken 2007/08, it would have been an error for 3 year time value calculation.
Hope this makes things clear.
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