ValuationAdvanced

Discounted cash flow

A DCF estimates the present value of future cash. Its strength is not to produce an exact figure, but to force the connection of growth, margins, reinvestment, risk and time.

3 min read Practical guide

By the end

You will build a simple DCF and understand which assumptions dominate the result.

Flow and horizon

Project FCF available to all financiers or shareholders, without mixing them. A 5–10 year horizon should converge towards mature growth and margins; extrapolating extraordinary advantages indefinitely inflates value.

Discount rate

The rate reflects time value and risk. Flows for the firm are discounted with WACC; for shareholders, with equity cost. Don't compensate for an optimistic scenario by arbitrarily using a high rate: model explicit risks and raise awareness.

Terminal value

It usually dominates the result. With perpetual growth: TV = next FCF / (rate − growth), where growth must be less than rate and reasonable for a mature economy. An output multiple can also be used, checking consistency.

Example

Terminal FCF 100, rate 9% and growth 3% gives 1,717. With 8% and 4%, it gives 2,600: small changes alter the value 51%.

From EV to price

Add present value, subtract debt and other rights, add non-operating cash and divide by diluted shares. Presents rate and growth matrix, scenarios and safety margin.

Definition of flow.

Coherent reinvestment.

Compatible rate and growth.

Debt/cash.

Dilution and sensitivity.

From data to a decision

Which assumptions explain value?

This guide cannot predict the next move on its own. It can build a conditional reading: what supports upside, what increases downside risk, and which evidence must appear before acting.

Favourable reading

Prudent growth, margin, and reinvestment assumptions create a margin of safety.

Adverse reading

Value depends on a distant terminal value or an overly low discount rate.

Required confirmation

Run sensitivity on margin, terminal growth, and cost of capital.

Reasoned example

If changing the rate from 8% to 10% removes all upside, the thesis is fragile.

Applied workshop

Turn the explanation into a process

Follow these steps in order and keep the result, so you can repeat the analysis and identify what changed your decision.

1Forecast unit economics rather than isolated percentages: customers, price, margin, reinvestment and working capital.
2Connect growth with required capital and calculate explicit FCF by scenario.
3Choose a discount rate consistent with currency and risk and limit terminal-value weight.
4Test terminal growth, margin and discount rate; present a range, not a precise decimal.

Review questions

Which assumption explains most of the value?
Does reinvestment support that growth?
Does the bear case preserve solvency?

Worked case

Terminal value sensitivity

With terminal FCF 100, rate 9% and growth 3%, the terminal is worth 1,667 before the temporary adjustment. Changing to 8% and 4% raises it to 2,500. A small variation produces 50% more value.

It presents a matrix, not a single result. Check that the necessary reinvestment allows the chosen growth and that the rate corresponds to the risk of the flow.

Decision rule

Use DCF to discover dominant assumptions, not to fake decimal precision.

Put it into practice

Create a five-year DCF and a 3x3 rate and terminal growth matrix. Explain why you would use a range.