What is a DCF and how does it value a company from fundamentals?
Master DCF valuation: free cash flow projections, WACC discounting, terminal value, and enterprise value calculation for investment banking interviews.
On this page
- Concept
- Intuition
- Components
- Standard framework
- Free cash flow (FCF)
- Weighted average cost of capital (WACC)
- Terminal value
- Which terminal value method is better?
- The bridge from enterprise value to share price
- Follow-up traps
- "Why add back depreciation?"
- "Why use WACC?"
- What actually moves a DCF
- Interview script
"A bird in the hand is worth two in the bush." (Aesop, the original DCF concept)
Concept
A DCF values a company by projecting its future cash flows, then discounting them back to today's dollars using a rate that reflects the riskiness of those cash flows. The logic is simple: a dollar today is worth more than a dollar tomorrow, and a risky dollar is worth less than a safe one. DCF is the only intrinsic valuation method: it derives value from fundamentals, not market comparisons.
Intuition
DCF is rooted in one principle: the value of any asset is the present value of its future cash flows. This applies to bonds, stocks, real estate, or an entire company.
The discount rate exists because cash now can be invested elsewhere. If you're tying up capital in this business, you need compensation for waiting and for risk.
The terminal value exists because companies (theoretically) live forever, but you can only forecast so far.
Every piece of the DCF formula is either an expected cash payment or a mechanism to translate future cash into today's dollars.
Critical insight: Terminal Value drives 60-80% of the output, making the model highly sensitive to growth and WACC assumptions. Interviewers ask DCF questions to test if you understand this.