What is the Difference Between Discounted and Undiscounted Cash Flows?

The main difference between discounted and undiscounted cash flows lies in the consideration of the time value of money. Discounted cash flows (DCF) take into account the time value of money, while undiscounted cash flows do not. Here are the key differences between the two:

1. Time Value of Money: Discounted cash flows consider the time value of money, which means that money available today is worth more than the same amount in the future due to its potential earning capacity. Undiscounted cash flows do not account for the time value of money and are therefore less accurate.
2. Discount Rate: Discounted cash flows are adjusted using a discount rate to arrive at a present value estimate, which is used to evaluate the potential for investment. Undiscounted cash flows do not use a discount rate and simply add up the projected cash flow without accounting for the time value of money.
3. Investment Appraisal: Discounted cash flows are used in investment appraisal techniques such as Net Present Value (NPV) to evaluate the potential of an investment. Undiscounted cash flows are not used in investment appraisal as they do not provide an accurate representation of the investment's potential.

In summary, discounted cash flows provide a more accurate valuation of investments by considering the time value of money, while undiscounted cash flows do not account for this factor, making them less accurate for investment appraisal.

Comparative Table: Discounted vs Undiscounted Cash Flows

The main difference between discounted and undiscounted cash flows lies in the consideration of the time value of money. Here is a table summarizing the differences between the two:

Discounted cash flows are calculated using the formula: $$\text{Discounted cash flows} = \frac{\text{CF}1}{\text{(1+r)}^1} + \frac{\text{CF}2}{\text{(1+r)}^2} + … + \frac{\text{CF}_n}{\text{(1+r)}^n}$$, where CF is the cash flow, r is the discount rate, and n is the number of periods. On the other hand, undiscounted cash flows do not account for the time value of money and are less accurate.