DCF Interview Questions

Yes — cost of equity is almost always higher than cost of debt because equityholders bear more risk as residual claimants with no guaranteed cash flows, and the tax deductibility of interest further widens the gap.

Reducing the tax rate increases enterprise value because higher after-tax operating cash flows (EBIT × (1 − t)) more than offset the slight WACC increase caused by a smaller interest tax shield on debt.

The discount rate accounts for the time value of money, a risk premium for the uncertainty of each coin flip, and the opportunity cost of deploying capital here instead of the next-best alternative investment.

CapEx down 10 has the greatest impact, boosting FCF by a full 10, since it flows dollar-for-dollar with no tax friction, whereas revenue up 10 only adds 6 after tax and depreciation down 10 actually hurts FCF by 4.

Because NOPAT is an accrual measure, and an increase in net working capital means cash was tied up in operations (e.g., uncollected receivables or inventory buildup) that the income statement doesn't reflect, so you subtract it to convert accrual profits into actual cash.

WACC is the weighted average cost of capital—the blended required return across equity and debt investors—calculated as (E/(E+D)) × Ke + (D/(E+D)) × Kd × (1−t), using market-value weights and CAPM for cost of equity.

Use CAPM: Cost of Equity = Risk-Free Rate + Beta × Equity Risk Premium — for example, 4.3% + 1.2 × 6.0% = 11.5%, where the risk-free rate is the 10-year Treasury yield, beta measures stock sensitivity, and ERP is roughly 5–7%.

Using WACC = (0.50 × Ke) + (0.50 × 7%), set 12% = 0.50Ke + 3.5%, solve to get Ke = 8.5% / 0.50 = 17%.

You can only say that, all else equal, the companies would have the same Enterprise Value because EV is based on unlevered free cash flow, which is 100 for both. But from the information given alone, you cannot determine the exact difference in Equity Value. The lower LFCF at Company A suggests more cash is going to debtholders or other financing claims in that period, so Company A's Equity Value would generally be lower than Company B's if operating outlook and EV are otherwise the same. However, the exact equity value difference cannot be inferred from a one-period 5 LFCF gap.

Project unlevered free cash flows, discount them and a terminal value back to the present using WACC to get enterprise value, then subtract net debt and divide by diluted shares to find implied share price.

WACC has risen roughly 200-300+ bps since 2021, driven primarily by the ~275 bps increase in the risk-free rate flowing through to both the cost of equity (via CAPM) and cost of debt, compounded by a shift toward equity-heavier capital structures.

Raise debt: a 10x P/E implies a 10% earnings yield, which is the implied cost of equity. The 10% pre-tax cost of debt becomes 8% after tax assuming the standard 20% interview tax rate, so debt is cheaper.