Discounted cash flows mean cash flows with the impact of the time value of money. Discounted cash flows is a technique of evaluating that a stream of cash flows is worthwhile or not. Also discounted cash flows are used for valuation purposes. To value the price of a share, the dividend valuation method is used. To discount the cash flows associated with a share i.e. dividend is discounted using the required rate of return. Since a share is expected to pay a dividend of $2.50 for perpetuity, the cash flow will be divided by the required rate of return of 9.2%. Using the discounted cash flows approach the value of the share will be
MV = $2.50 / 0.092 = $27.174
Similarly, the value of a bond can also be calculated by discounting the interest payments and redemption value at appropriate discount factors to reach the market value of a bond.
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