What is the primary purpose of a Discounted Cash Flow (DCF) analysis?

The primary purpose of a Discounted Cash Flow (DCF) analysis is to estimate the value of an investment based on its expected future cash flows. This method provides a systematic approach to valuing an asset by forecasting the cash that it is expected to generate in the future and then discounting those cash flows to their present value using an appropriate discount rate.

This approach is founded on the principle of the time value of money, which states that a dollar received today is worth more than a dollar received in the future due to its potential earning capacity. By projecting future cash flows and calculating their present value, analysts can determine whether an investment is undervalued or overvalued compared to its current market price. This makes it an essential tool for investors and financial analysts when making investment decisions.

While assessing stock prices, analyzing revenue growth, and evaluating investment risk are important aspects of financial analysis, they do not encapsulate the primary intent of a DCF analysis, which is focused specifically on valuing the investment based on its future cash generating potential.