# How to use DCF, NPV and ROI

DCF NPV ROI calculation
Recent activity on Jun 27, 2017
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Hi all,

I have a few questions about NPV and DCF:

1- Where would you use one or the other? Investment cases / Valuation cases
2- When you use ROI in lets say an investment case, would you use the result of DCF, NPV, or neither?

Thanks a lot

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NPV= Net Present Value- [-investment +( Summation of FCF/(1+wacc)^t from 1 to t)].This is a basic formula, it is way more involved than the substituting numbers in the formula, typical you would need to create a DCF model based on a pro forma to get the FCF and terminal value. We could spend hours discussing adjustments, discount rate calculation (WAAC or APV), growth rates, and terminal valve assumptions etc. but for a case situation, the intuition and application of the formula rather than the development of the model would be required.

In short, NPV of a deal is today's value of all future streaming of free cash flow generated from the deal in question. If it’s above 0 or positive then you should do the project, if below 0 or negative, then you shouldn't do the project.

So all you need in essences is FCF and the Discount rate or WACC and the time horizon to evaluate.

P.S- Clarify with the interview the approach and formula you plan to use, as well as the assumptions.

On the other hand, ROI is simply (N.I/Investment) this doesn't take discount rate or WACC into account, which makes it inferior to NPV, You could call ROI a payback estimator (inverse of ROI= Payback) that doesn't take risk, inflation and opportunity cost into account. ROI is a quick and dirty estimate to sniff test the deal.

For instance, If payback time requested by your client is 2 years and your ROI/payback analysis yields 20% or 5years then you can almost be certain its not a +NPV project and should be cautious about making the deal, else other strategic reasons support doing so. For example, accepting the deal because it’s serves as a structural barrier to deter entry by competition etc.