Hi, share your knowledge with the community!

How to use DCF, NPV and ROI

Someone asked on Jun 27, 2017 - 2 answers

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

  • Upvotes
  • Date ascending
  • Date descending
Olu replied on Jun 27, 2017

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.

Kamaraju updated his answer on Jun 27, 2017

NPV and ROI can be used interchangeably. But when standard or industry standard interest rate is given, ROI is calculated and compared with standard interest. Otherwise, in general NPV is calculated and compared between two options.


Related BootCamp article(s)

Net Present Value - NPV

Use the Net Present Value (NPV) to compare investments with different volatile cash-flows over time and quantitatively assess their attractiveness.

10 Comment(s)


Valuation case studies require you to estimate how much a firm, patent, or service is worth. For these cases, use the Discounted Cash Flow method or the Industry multiple method.

7 Comment(s)

Related case(s)

The municipal utility Hamburg Energized is a local energy retail (power and gas) and distribution grid company active in the city of Hamburg. The majority of shares of Hamburg Energized is held by the city itself. As the distribution system operator of Hamburg, Hamburg Energized is responsible for t ... Open whole case

PE Portfolio Strategy

Solved 3.8k times
4.1 5 310
| Rating: (4.1 / 5.0)

We are a private equity firm operating primarily in the automotive industry. We would like you to figure out whether we should increase our portfolio in the sensor market or not. We would like you to do a profit/margin growth potential analysis and tell us how we can add value to this company given ... Open whole case

Castaway Company

Solved 200+ times
2.6 5 10
| Rating: (2.6 / 5.0)

Castaway Company, a biotechnology startup, has developed a new seed for corn, which produces twice as much corn syrup as the seeds that are currently being used. Now, they want to sell the company and are interested in finding out how much it is worth. Open whole case

Clarence Mobile

Solved 200+ times
3.5 5 2
| Rating: (3.5 / 5.0)

The client, Clarence Mobile, is a company producing cellphones for retail clients. The company's performance regarding their financial situation has decreased over the past four years. Especially their Return on Investment (ROI) is of key concern. The CEO has asked you to examine this, and answer ... Open whole case