Discounted Cash Flow (DCF)

Discounted cash flow analysis values an investment by projecting its future cash flows and discounting each one back to the present at a required rate of return. It extends cash on cash return from a single year to the whole holding period, including the sale.

Cash on cash asks what the first year pays on your cash. DCF asks what every year plus the exit is worth today. Five years of the default $9,512 cash flow, discounted at 8%, is worth about $37,980 now, before counting any sale proceeds.

The two answers can disagree. A property with low cash on cash return and strong expected rent growth can look better in a DCF than one with high cash flow and no growth. The discount rate is the judgment call; it should reflect what else you could earn on the same money at similar risk.

Further reading: Discounted Cash Flow (DCF) on Wikipedia.