DCF Valuation: Discounted Cash Flow Explained
After understanding Intrinsic vs Relative Valuation Explained, DCF answers the core intrinsic valuation question: what is a company worth based on the cash flows it can generate? In interviews, DCF matters because it tests whether you can move from accounting numbers to Free Cash Flow to Firm, calculate Weighted Average Cost of Capital, discount cash flows and terminal value, and convert enterprise value into equity value.
- DCF Valuation follows a step-by-step flow: Project FCF, Calculate WACC, Discount Cash Flows, Terminal Value, Enterprise Value, Equity Value.
- EV = Ξ£ [FCFβ / (1+WACC)α΅] + [TV / (1+WACC)βΏ] - Equity Value = EV - Net Debt.
- DCF in One Line: Equity Value = Sum of [FCFF discounted at WACC] + [Terminal Value discounted at WACC] - Net Debt.
- FCFF: Free Cash Flow to Firm = EBITΓ(1-T) + D&A - ΞNet Working Capital - Capex.
- WACC: KeΓ[E/(D+E)] + KdΓ(1-T)Γ[D/(D+E)] where Ke = Rf + Ξ²(Rm-Rf).
- Always compute BOTH Terminal Value methods and triangulate: Gordon Growth and Exit Multiple.
- Finish with sensitivity analysis on WACC and terminal growth, and present a valuation range, not a point estimate.
DCF Valuation Big Picture
DCF Valuation is a workflow that starts with projected Free Cash Flow to Firm and ends with intrinsic share price. The model values the operating business first as enterprise value, then subtracts net debt to arrive at equity value.
Equity Value = Sum of [FCFF discounted at WACC] + [Terminal Value discounted at WACC] - Net Debt
Terminal Value Methods
Terminal Value can be computed using the Gordon Growth method or the Exit Multiple method. Always compute BOTH TV methods and triangulate.
In India, Gordon growth g β nominal GDP growth (~9-11%). Exit multiple should match current trading multiples of mature peers.
Step 1 - Building FCFF from Net Income
The bridge from Net Income, what accountants report, to FCFF, what the DCF model needs, is a critical calculation that appears in every IB technical interview.
Alternative Direct Build: FCFF = EBIT Γ (1-T) + D&A - ΞNWC - Capex
Using above numbers: EBIT = βΉ680 Cr (PAT βΉ450 + Interest βΉ80 + Tax βΉ150) - EBITΓ(1-0.25) = βΉ510 + D&A βΉ90 - ΞNWC βΉ40 - Capex βΉ120 = βΉ440 Cr FCFF β
Both methods give identical result. Top-down from EBIT is faster; bottom-up from NI is used when you need to reconcile to reported financials.
Step 2 - WACC Worked Calculation
WACC calculation is tested verbally in every IB interview. Walk through this example until you can do it in under 90 seconds.
Ke=14%, Kd=8%, T=25%, D/E=0.5: D/E = 0.5 - D/(D+E) = 0.5/1.5 = 33.3%, E/(D+E) = 66.7%. Kd after-tax = 8% Γ 0.75 = 6.0%. WACC = 14.0% Γ 66.7% + 6.0% Γ 33.3% = 9.33% + 2.0% = 11.33%.
Step 3 - Full DCF Model
Company: IndoMake Ltd. Revenue base FY25E: βΉ2,000 Cr. WACC: 11.3%. Terminal growth: 5.5%. Shares outstanding: 100 Cr. Net Debt: βΉ500 Cr.
Terminal Value Cross-Check
If comparable companies trade at 8ΓEV/EBITDA and IndoMake's FY29E EBITDA = βΉ770 Cr:
TV (exit) = βΉ770 Cr Γ 8Γ = βΉ6,160 Cr - PV = βΉ6,160 Γ 0.585 = βΉ3,604 Cr.
Gordon model gives EV βΉ5,317 Cr; Exit multiple gives EV ~βΉ4,557 Cr.
Result: Implied share price range βΉ41 - βΉ48. Present as a range, not a point estimate. The gap reflects uncertainty - which is why sensitivity analysis is essential.
Step 4 - Sensitivity Analysis
Always stress-test the DCF by varying the two most sensitive assumptions: WACC and terminal growth rate. Present the output as a football field table.
Green border = Base case (11% WACC, 4% growth). Green values = upside. Red values = downside.
Structuring a DCF Valuation Interview Answer
"Walk me through a DCF."
The #1 way candidates get this wrong is presenting a single point estimate instead of a valuation range. Finish by saying you would run a sensitivity table on WACC Γ terminal growth and present a football field.
The most frequent error is treating the DCF output as one precise number. The gap between Gordon Growth and Exit Multiple reflects uncertainty - which is why sensitivity analysis is essential and the result should be presented as a range, not a point estimate.
Conclusion
DCF Valuation is an interview-ready workflow: project FCFF, calculate WACC, discount forecast cash flows and terminal value, derive enterprise value, subtract net debt, and stress-test the result. The final takeaway is simple: DCF is strongest when it produces a defensible valuation range, not a single number.