Previous ticker arrow

How to Calculate the Present Value of Free Cash Flow

By Motley Fool Staff – Updated Apr 29, 2025 at 11:32 PM EST

Key Points

Calculate the present value of each year's cash flow by dividing by (1 + discount rate)^number of years.
Sum all present values to find the total value of projected cash flows, which in this example is $326.
A 10% discount rate gives a fair valuation for selling a business based on projected cash flows.

The basic premise of finance is that money has time value -- a dollar in hand today is worth more than a dollar in the future. The study of finance seeks to make it possible to compare the value of a future dollar in terms of present dollars. Below, we'll show you how to calculate the present value of a stream of free cash flows expected over several years.

Loading paragraph...

A small child hitting a baseball off of a tee. — Image source: Getty Images.

Loading image...

Loading paragraph...

You want to know what the hot dog business is theoretically worth. You believe the hotdog stand is a relatively low-risk venture and assume the cash flows should be discounted at a rate of 10% per year.

Once you have the discount rate you like (10%) and the free-cash-flow projections (listed above), the next step is to start doing the math.

Discounting the cash flows

To calculate the present value of any cash flow, you need the following formula: Present value = expected cash flow ÷ (1 + discount rate)^number of periods

Year one

For year one, the math would look like this:

Present value = $50 ÷ (1 + .10)^1
Present value = $50 ÷ (1.10)^1
Present value = $50 ÷ 1.10
Present value = $45.45

In completing the steps, you learn that the present value of $50 is $45.45 at a 10% discount rate. Hence, the year one cash flow of $50 has a present value of $45.45.

Loading paragraph...

Year two

The year two cash flow would be discounted similarly:

Present value = $75 ÷ (1 + .10)^2
Present value = $75 ÷ (1.10)^2
Present value = $75 ÷ 1.21
Present value = $61.98

Thus, the second-year free cash flow of $75 is equivalent to having $61.98 in hand today, assuming we can earn a 10% return on our money.

These steps are repeated until every cash flow has been discounted. I'll skip the work for the remaining cash flows and just show you the answers. Compare the answers you calculate for each cash flow to those in the table below.

Loading paragraph...

Calculating the present value of free cash flow. Author's calculations.
Year	Expected Cash Flow	Present Value
1	$50	$45.45
2	$75	$61.98
3	$100	$75.13
4	$110	$75.13
5	$110	$68.30
Total	$445	$326.00

Loading table...

The last and final step is to sum up all the present values of each cash flow to arrive at a present value of all the business's projected free cash flows. We calculated the present value of the total free cash flows at $326. Thus, if you were to sell this business based on its expected cash flows and a 10% discount rate, $326.00 would be a very fair price.

Take careful note that the higher the discount rate and the longer the time period you expect to wait for each cash flow, the less value it will have in the present. Notably, in our example, we expect $110 in cash flows for the year four and year five periods. However, the year four cash flow is worth more because it is discounted by fewer periods than the year five cash flow.