DCF Overview
Discounted Cash Flow (DCF) calculates intrinsic value by projecting future cash flows and discounting them back to present value. It is the foundation of fundamental valuation.
The DCF Formula
Present Value = Sum of [FCF / (1 + r)^n] + Terminal Value / (1 + r)^n
Where FCF = Free Cash Flow, r = discount rate, n = year
Building a DCF Model
Step 1: Project Free Cash Flow
- Start with historical FCF
- Project 5-10 years of future FCF
- Consider growth rates, margins, capital needs
Step 2: Calculate Discount Rate (WACC)
Weighted Average Cost of Capital reflects required return:
- Cost of equity (often 8-12%)
- Cost of debt (after-tax interest rate)
- Weighted by capital structure
Step 3: Calculate Terminal Value
Value of all cash flows beyond projection period. Often 60-80% of total value.
Sensitivity Analysis
DCF outputs are highly sensitive to assumptions. Always run scenarios with different growth rates and discount rates to see the range of possible values.