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IB Prep

DCF · 5 min read

Walk me through a DCF

A discounted cash flow (DCF) values a company on the cash it will generate in the future, discounted back to today. The interview answer is a short, ordered walk-through.

The answer, in order

  1. Project the company's unlevered free cash flow for 5–10 years.
  2. Work out the discount rate: the weighted average cost of capital (WACC).
  3. Estimate a terminal value for everything after the forecast, using a perpetuity growth rate or an exit multiple.
  4. Discount the cash flows and the terminal value back to today and add them up. That's enterprise value.
  5. Bridge to equity value and divide by diluted shares for a value per share.

Unlevered free cash flow

EBIT × (1 − tax rate), plus depreciation and amortisation, minus capital expenditure, minus the increase in working capital. It's calculated before interest, so it belongs to lenders and shareholders alike, which is why you discount it at WACC.

Terminal value

With perpetuity growth, terminal value = next year's cash flow ÷ (WACC − growth rate). With an exit multiple, it's final-year EBITDA × a sensible EV/EBITDA multiple. Good candidates cross-check one against the other.

Check you've got it

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Put in order

Put the steps of an unlevered DCF in order.

Use the arrows to move each step up or down.

  1. 1Project unlevered free cash flow for 5–10 years
  2. 2Discount the cash flows and terminal value to today
  3. 3Add them up to get enterprise value
  4. 4Work out the discount rate (WACC)
  5. 5Bridge to equity value and divide by diluted shares
  6. 6Calculate the terminal value