Discounted Cash Flows also known as Net Present Value of Discounted Cash Flows is a valuation method which discounts future cash flows back to the present to estimate the attractiveness of a real estate investment.

Let’s assume we are thinking about investing in an income producing property. The discounted cash flows calculation would use the initial investment amount, a series of estimated yearly future after-tax cash flows, the after-tax sales proceeds in a given year and a discount rate determined by the investor. The discount rate used by the investor reflects the investment risk and anticipated return required to take that risk or put simply, the investor enters the rate of return that he would like to make on the investment. A negative discounted cash flows / net present value would indicate that the investment doesn’t meet investor expectations. A positive discounted cash flows indicates that the investment meets investor expectations. The larger the net present value, the better the investment.

Discounted Cash Flows – Example. We have the following data for an income property that we are considering purchasing. We would like to make 20% ( Discount Rate = 20 % ) on our initial investment amount of $92,073. We calculate a positive Net Present Value of 67,561 for the series of estimated yearly after-tax Cash Flows and after-tax sales proceeds in year 10.

A calculated Discounted Cash Flows or Net Present Value of $67,561 tells us the following. We are averaging at least 20% per year on our initial investment amount of $92,073. Because we have a large net present value \ discounted cash flows value, this indicates that we are averaging quite a bit more than 20% per year on our investment. The investment easily meets our financial requirements of a minimum 20% return. It is a buy from a financial perspective.