DCF Interview Questions

Politely decline to name a stock to buy, and offer to walk through how you would evaluate one instead. Recommending stocks is usually the job of equity research analysts (people who publish buy, hold, or sell ratings for investors) and the buy-side (firms such as hedge funds and mutual funds that invest money). Investment bankers advise companies on deals, and banks keep that work separate from stock recommendations. Then show your judgment with a pitch framework: the business, the thesis, valuation, catalysts, and risks.

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 7.50 after tax and depreciation down 10 actually hurts FCF by 2.50.

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 annual return a company has to earn to satisfy everyone who funds it. It is the rate you discount unlevered free cash flow at in a DCF. You build it by weighting the cost of equity and the after-tax cost of debt by each one's share of total capital, measured at market value: WACC = E/(D+E) x cost of equity + D/(D+E) x cost of debt x (1 - t). Cost of equity comes out of CAPM. Cost of debt is the yield the company pays on its debt today, and it gets tax-affected because interest is deductible. The equity term does not.

You usually get the cost of equity from the Capital Asset Pricing Model (CAPM): cost of equity = risk-free rate + beta × equity risk premium. The risk-free rate is typically a long-term government bond yield. Beta is how much a stock moves relative to the overall market. The equity risk premium is the extra return investors expect for holding stocks over risk-free bonds.

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

Assuming the same discount rate, enterprise value is the same for both. A's equity value (the part of the company that belongs to shareholders) is most likely lower by A's net debt, a figure these numbers do not give you. Enterprise value (the value of the whole business to lenders and shareholders together) comes from unlevered free cash flow, the cash the operations produce before any payment to lenders. Both companies produce 100. The 5 gap to levered free cash flow (the cash left for shareholders after paying lenders) is money going to A's lenders, so A carries debt. Equity value equals enterprise value minus net debt (debt minus cash), so A's shareholders own less by the debt balance, not by the 5.

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 7.5% after tax assuming the standard 25% tax rate, so debt is cheaper.