Discounted cash flow

A DCF projects the cash a business will generate for all capital providers, discounts it at a rate reflecting risk, and adds a terminal value for the years beyond the forecast. The result is enterprise value. It is the most fundamental method and the most sensitive to assumptions.

Start with EBIT, subtract taxes on EBIT, add back depreciation and amortisation, subtract capital expenditure and increases in working capital. Interest is excluded because the cash flow belongs to both debt and equity holders; financing is captured in the discount rate instead.

The weighted average cost of capital blends the cost of equity and after-tax cost of debt by their market-value weights. The cost of equity is usually estimated with CAPM: risk-free rate plus beta times the equity risk premium. Debt is cheaper because it is senior and interest is tax-deductible.

Terminal value often represents 60–80% of a DCF. The perpetuity growth method grows final-year cash flow forever at a modest rate (usually below long-run GDP growth). The exit multiple method applies an EBITDA multiple to the final year. Cross-check one against the other: an implied 4% perpetual growth rate signals an aggressive multiple.

Always show a table varying WACC and terminal growth or exit multiple. A one-point change in WACC can move value by 15% or more. If the conclusion only holds at one corner of the table, it is not a conclusion. Compare the DCF output to comps; a large gap needs an explanation you can say in one sentence.