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DCF.

Aka. Discounted cash flow · DCF analysis
All terms

What is a DCF?

A discounted cash flow (DCF) values a business as the sum of the cash it is expected to generate in the future, each year discounted back to today at a rate that reflects the risk and time value of that money. It is the most fundamentals-driven of the valuation methods: it asks what the company is intrinsically worth, independent of what comparable companies happen to trade at.

The logic is that a dollar arriving in five years is worth less than a dollar today, and a riskier dollar is worth less than a safer one. The discount rate captures both. Project the cash, discount it, add it up — the total is the intrinsic value.

A DCF is only as good as its inputs. Small changes in the growth rate, the discount rate, or the terminal assumptions swing the answer dramatically, which is why a DCF is always run as a range, never a single number.

How a DCF is built

An unlevered DCF — the standard for valuing the whole enterprise — follows a set sequence.

  1. Project free cash flow for an explicit forecast period, usually five to ten years. Unlevered free cash flow is the cash the operations throw off before financing.
  2. Choose a discount rate. For an enterprise DCF this is the weighted average cost of capital (WACC), blending the cost of equity and after-tax cost of debt.
  3. Discount each year's cash flow to present value using that rate.
  4. Add a terminal value to capture the cash flows beyond the forecast horizon, then discount it back as well.
  5. Sum the pieces to get enterprise value, then bridge to equity value by netting debt and other claims.

The terminal value typically accounts for the majority of the total — which is precisely why its assumptions deserve the most scrutiny.

What a DCF is good and bad at

A DCF shines when cash flows are reasonably predictable — stable, cash-generative businesses where a forecast can be defended. It forces an analyst to articulate exactly what they believe about growth, margins, and capital intensity, and it values a company on its own merits rather than the mood of the market.

It struggles with early-stage, cyclical, or rapidly changing businesses, where the forecast is largely guesswork and the terminal value dominates the answer. The discipline is to use the DCF as one bar on the valuation summary — a check on the multiples-based methods — rather than a precise verdict on its own.

Frequently asked.

5 questions
01 What discount rate should a DCF use?

For an unlevered DCF that values the whole enterprise, the standard rate is the weighted average cost of capital (WACC), which blends the cost of equity and the after-tax cost of debt in proportion to the capital structure. A levered DCF that values equity directly uses the cost of equity instead.

02 Why does the terminal value matter so much?

Because it usually represents the majority of a DCF's total value — often well over half. The explicit forecast covers only a handful of years; everything beyond it is captured in one terminal figure. Small changes to the perpetuity growth rate or exit multiple therefore move the whole valuation, so terminal assumptions get the most scrutiny.

03 What is the difference between levered and unlevered DCF?

An unlevered DCF projects free cash flow before financing and discounts it at WACC to reach enterprise value. A levered DCF projects cash flow after interest and debt service and discounts it at the cost of equity to reach equity value directly. The unlevered approach is the more common default.

04 When is a DCF the wrong tool?

When cash flows cannot be forecast with any confidence — early-stage startups, deeply cyclical businesses, or firms undergoing rapid structural change. In those cases the terminal value dominates and the output becomes a function of assumptions rather than fundamentals, so multiples-based methods carry more weight.

05 Why is a DCF shown as a range?

Because its output is extremely sensitive to the discount rate, growth assumptions, and terminal value. Analysts sensitize these inputs to produce a low-to-high band rather than a false point estimate — which is exactly the range that appears as the DCF bar on a football field chart.

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