DCF Valuation: Method

Discounted Cash Flow Method

What is valued

The enterprise DCF values the operating business as the present value of the unlevered free cash flows it will generate: cash from operations after tax and after the investment needed to sustain it, before any payment to debt or equity holders. Discounting at the weighted average cost of capital, the return the providers of debt and equity together require, gives the enterprise value. Subtracting net debt (debt less cash) gives the value of the equity, and dividing by the diluted share count gives a value per share.

The discount rate

The cost of equity comes from the capital asset pricing model, k_e = r_f + β × ERP: the risk-free rate plus the stock's beta times the equity risk premium. The cost of debt is the borrowing rate after the tax shield, r_d(1 − t). The WACC weights the two by market values. Every input is a judgment: the risk-free rate should match the horizon, beta is estimated with error, and the premium is argued over at the level of a percentage point, which is why the sensitivity grid matters more than the point value.

Terminal value

Explicit projections stop after a few years, and the value beyond them is captured in one number. The Gordon growth model treats the last cash flow as growing at g forever, TV = FCF_N(1 + g)/(WACC − g); it is very sensitive to the gap WACC − g, and g cannot exceed the long-run growth of the economy without implying the business eventually becomes the economy. The exit multiple treats the business as sold at a multiple of its final-year EBITDA taken from comparable transactions. Each method implies the other's parameter, and the tool reports both implied values as a cross-check: a Gordon terminal value implying 25 × EBITDA, or a multiple implying 8 percent perpetual growth, signals an inconsistent assumption. The terminal value is discounted from the end of the last projected year even under the mid-year convention.

Reading the result

The share of enterprise value sitting in the terminal value is reported; above about three quarters, the projection years matter little and the valuation is really a statement about the terminal assumptions. The sensitivity grid varies the discount rate by ±2 points and the growth rate by ±1 point; the spread across the grid is the honest range of the answer.

Not included

Non-operating assets, minority interests and preferred stock in the equity bridge, changing capital structure or tax rates over the projection, and the adjusted-present-value or dividend-discount forms.