Discounted cash flow analysis¶

Sympheny uses discounted cash flow (DCF) analysis to determine the present value of expected future cash flows. This approach is crucial for long-term energy projects, as it accounts for financing factors such as the cost of capital, loan structures, and risk premiums — ensuring that both initial investments and future cash flows are properly evaluated.

Interest rate:

• Interest rate as financing cost: when you take out a loan (especially an amortized one, with regular payments), the interest rate directly reflects the cost of borrowing that money — it's what the lender charges you.
• Discounting future cash flows: the interest rate can also be used to calculate the present value of money expected in the future (a process called discounting). In this case, it reflects the opportunity cost of capital — the return you might earn if you invested the money elsewhere. A risk premium is added to this rate to cover risks such as price fluctuations or project-specific uncertainties.
• Dual use: in practice, the interest rate is often used both as the cost of financing and as part of the discount rate. The effective discount rate can be constructed by combining the cost of financing with an additional risk premium.

Inflation rate:

The inflation rate is the expected annual percentage increase in the general price level of goods and services. It indicates the decline in the purchasing power of money over time and plays a critical role in long-term financial analysis, since it affects both the costs and revenues of future cash flows in real terms.

The assumption is that the rate of inflation is the same for all costs.

Discount rate:

This rate converts future cash flows into their present value, reflecting the opportunity cost of capital and associated risks. The discount rate is derived by adjusting the nominal interest rate for inflation, producing a real rate that excludes inflation effects.

The discount rate also plays a key role in converting one-time costs into an equivalent annual cost (EAC). This is done using the capital recovery factor (CRF).

Weighted average cost of capital (WACC):

In energy planning, the WACC is often used as the discount rate in DCF analysis. When cash flows are expressed in real terms (with inflation already accounted for), you might set WACC as the interest rate with inflation assumed to be zero, which results in the discount rate aligning with the interest rate.

In Sympheny, you define these parameters along with other inputs in the Stage Parameters step. See Stages parameters for details.