Discounted After-Tax Cash Flow

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Discounted After-Tax Cash Flow

What Is Discounted After-Tax Cash Flow?

The discounted after-tax cash flow technique is a way of evaluating an investment that considers the amount of money earned as well as the cost of capital and the appropriate marginal tax rate.

Discounted after-tax cash flow is similar to basic discounted cash flow (DCF), but it includes tax consequences.

Key Takeaways

  • Discounted after-tax cash flows are the present value of future income streams that have been adjusted for each cash flow’s projected tax bill.
  • After-tax discounting gives a more accurate assessment of the attractiveness of a project or investment and may also account for non-cash flows such as depreciation.
  • The profitability index and the discounted payback time of a project or investment are calculated using discounted after-tax cash flows.

Understanding Discounted After-Tax Cash Flows

The goal of discount analysis is to calculate the amount of money an investor would get from an investment after adjusting for the time value of money. Because money may be invested, the temporal value of money suggests that a dollar now is worth more than a dollar tomorrow. As a result, a DCF analysis is applicable in any case where a person is spending money now with the intention of getting more money later.

The discounted after-tax cash flow technique is most often employed in real estate appraisal to evaluate if a property is likely to be a viable investment. When utilizing this valuation approach, investors must account depreciation, the tax bracket of the business that will possess the property, and any interest payments. It is a measurement of a property’s net cash flow after taxes and financing charges are deducted each year. The cash flow is discounted at the investor’s necessary rate of return to get the present value of the after-tax cash flows. If the present value of the after-tax cash flow exceeds the cost of the investment, the investment may be worthwhile.

  Tax Season Definition

Because the discounted after-tax cash flow is estimated after-tax, even if it is not a real cash flow, the tax charge must be calculated using depreciation. Depreciation is a non-cash expense that lowers taxes while improving cash flow. It is often removed from net operating income to calculate after-tax net income, which is then put back in to show the beneficial effect on after-tax cash flow.

Discounted After-Tax Cash Flows and Profitability

The profitability index, a ratio that examines the connection between the costs and benefits of a proposed project or investment, may be calculated using the discounted after-tax cash flow. The profitability index, also known as the benefit-cost ratio, is computed by dividing the present value of the discounted after-tax cash flow by the investment cost.

A project with a profitability index ratio equal to or higher than one is considered a potentially lucrative investment opportunity, according to the rule of thumb. In other words, if the present value of the after-tax cash flow is equal to or greater than the project cost, the project may be worthwhile.

Other Considerations

Because there are various methodologies for evaluating real estate investments, each with flaws, investors should not base their selection exclusively on discounted after-tax cash flow. Other real estate valuation methodologies, such as the cost approach, sale comparison approach (SCA), and income approach, may be used to analyze the property’s worth from numerous angles.

The discounted after-tax cash flow is also used to calculate an investment’s basic and discounted payback periods, letting an investor to predict how long it will take for a project to return its original investment.

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