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Discounted cash flows


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The generally accepted method for comparing different cash flow streams is the discounted cash flows (DCF) method. The basic idea is to find an immediate cash amount that is equivalent to a future cash amount. "Immediate" means cash now, as opposed to cash later. The immediate cash amount (the "present value") is obtained by discounting the future cash amount with a certain interest rate, thereby obtaining the present value of the cash flow.

Using discounted cash flows, the IRR is exactly the interest rate, that makes the net present value of all future cash flows equal to the initial investment.