What valuation method is commonly used to estimate the value of an investment based on future cash flows?

The Discounted Cash Flow (DCF) method is widely recognized for estimating the value of an investment by analyzing its expected future cash flows. This valuation method operates on the principle that money available now is worth more than the same amount in the future due to its potential earning capacity.

The DCF technique involves projecting the future cash flows that an investment is expected to generate and then discounting those cash flows back to their present value using a specific discount rate, usually reflecting the risk associated with the investment. By applying this method, investors can assess whether the projected returns justify the initial investment, making it a critical tool for investment decision-making.

In contrast, Cost-Benefit Analysis evaluates the strengths and weaknesses of alternatives in a decision-making process, primarily focusing on comparing the costs and benefits. Net Present Value, while similar to DCF in that it also deals with cash flows and their present value, specifically calculates the difference between the present value of cash inflows and outflows over a period of time. Return on Investment measures the efficiency of an investment relative to its cost but does not account for the time value of money in the way DCF does. Therefore, while related, they serve different purposes and employ different methodologies in investment valuation.