DCF & Valuation
Value a business from the cash it produces: free cash flow, WACC, beta, discounting, terminal value and the share price, built one piece at a time.
A discounted cash flow valuation asks one question: what is a business worth today, given the cash it will produce in the future? Most valuation methods compare a company with something else. A DCF values it on its own terms.
That is why it comes up in almost every investment banking interview, from a HireVue definition to a superday grilling on assumptions. The good news is that a DCF is only a handful of ideas stacked together. Learn each one properly and the whole thing becomes one story you can tell in two minutes.
Six chapters, one idea each. Every chapter explains the why, solves a real question with freshly drawn numbers, lets you move the inputs and watch the result change, runs the idea backwards, and ends with a check marked the same way as practice.
The whole DCF in one picture
Each step is a chapter. Follow the arrows and you have walked through a DCF.
- 5Bridge to a share price
Enterprise value to equity value to a price per share, then test it.
Chapters
Unlevered free cash flow
12 minThe cash a business produces for everyone who funds it, before any of them is paid.
- Build unlevered free cash flow from EBITDA, line by line
- Explain why interest is left out, and where its tax saving goes instead
- Work backwards from a model's free cash flow to the capex it assumes
- Tell unlevered from levered free cash flow, and pair each with its discount rate
WACC: the discount rate
12 minThe blended return lenders and shareholders demand, and why it is the rate for unlevered cash flow.
- Calculate the cost of equity with CAPM
- Blend equity and after-tax debt into WACC at market-value weights
- Back out the beta that a stated WACC implies
- Explain why more debt does not lower WACC forever
Levering and unlevering beta
10 minHow to borrow a peer's beta when its balance sheet looks nothing like yours.
- Unlever a peer's beta to isolate business risk
- Relever it at your company's target capital structure
- Carry the relevered beta through CAPM to a cost of equity
- Back out the leverage a model's beta assumes
Discounting and the mid-year convention
10 minWhy a future dollar is worth less today, and why DCFs assume cash arrives halfway through the year.
- Turn a future cash flow into a present value with a discount factor
- Apply the end-of-year and mid-year conventions, and say which gives more
- Back out the discount rate from a present value
- Know which cash flows the mid-year convention should not touch
Terminal value
12 minValuing everything after the forecast ends: perpetuity growth versus exit multiple.
- Calculate terminal value by perpetuity growth, growing the final cash flow one year first
- Calculate it by exit multiple and discount it to today
- Translate each method into the other: implied multiple and implied growth
- Explain why the gap between WACC and growth drives the answer
From DCF to share price
14 minBridging enterprise value to a price per share, and testing how much the answer depends on WACC.
- Discount a five-year forecast and a terminal value into enterprise value
- Bridge from enterprise value to equity value and a price per share
- Show how a one-point change in WACC moves the price, and why the move is lopsided
- Read a market price backwards as the WACC investors are using