Profitability Analysis; Discounted Cash Flow (DCF)

Abstract

The evaluation method most frequently used in the chemical industry for the primary measure of a project’s economic attractiveness is called either discounted cash flow (DCF) or internal rate of return (IRR) (even sometimes interest rate of return-IRR). These terms are used interchangeably, even though the words say that one is a cash flow and the others are rates of return. Sometimes to avoid semantic confusion the former is called discounted cash flow return on investment, DCF-ROI. They are a measure of the profitability of a project that takes into account the time value of money. This concept implies that receiving a dollar in income today is worth more than receiving a dollar next year, because today’s dollar could be invested and next year be worth one dollar plus the interest that it earned. With any project the investment may be made over a period of time (i.e., plant construction usually takes from one to three years), and the income generated will be over a longer period of time (i.e., 10 to 30 years) and often be quite variable. This method relates all aspects of the cash flow (after tax profit plus depreciation; capital spending; etc.) to a common time basis. Competitive projects, with their quite different spending and income flow can then be compared equally.