Question 1

What is a DCF valuation?

Accepted Answer

A discounted cash flow (DCF) valuation estimates what a business is worth today from the cash it's expected to generate. Each year's free cash flow is discounted at your required return, a terminal value covers the years after the forecast, and net cash is added to reach the equity value. With $1,000M of free cash flow growing 10% a year for five years and 6% for five more, 2.5% terminal growth, a 9% discount rate, $2,000M of net cash and 500M shares, the intrinsic value is $52.62 a share.

Question 2

How is the terminal value calculated?

Accepted Answer

This calculator uses the Gordon growth model: terminal value = year-10 cash flow × (1 + terminal growth) ÷ (discount rate − terminal growth). In the example, year-10 free cash flow is $2,155M, so the terminal value is $33,986M, worth $14,356M today, or 59% of the enterprise value. Because it's usually the largest part, keep terminal growth modest, at or below long-run economic growth.

Question 3

What discount rate should I use?

Accepted Answer

Use the return you require for the risk, often the company's weighted average cost of capital (WACC). Rates of 8% to 10% are common for large, stable companies, and smaller or riskier businesses call for more. The value is sensitive to this choice: in the example, 8% gives $62.15 a share and 10% gives $45.67, which is why the sensitivity table shows a range.

Question 4

What is a margin of safety?

Accepted Answer

It's a discount to your estimate of intrinsic value that you insist on before buying, in case the estimate is too optimistic. With a $52.62 intrinsic value and a 20% margin of safety, you'd buy below $42.10; with 25%, below $39.47.

Question 5

What are the limits of a DCF?

Accepted Answer

The result is only as good as the inputs: small changes to growth or the discount rate move the value a lot, and the terminal value often makes up more than half of it. A DCF suits companies with positive, fairly predictable cash flow and is hard to apply to start-ups that burn cash or to very cyclical businesses. Use it alongside other measures, such as price-to-earnings ratios.

Terminal growth ↓ / Discount rate →	7.0%	8.0%	9.0%	10.0%	11.0%
1.5%	$66.48	$56.11	$48.55	$42.81	$38.29
2.0%	$70.74	$58.88	$50.44	$44.15	$39.28
2.5%	$75.95	$62.15	$52.62	$45.67	$40.38
3.0%	$82.46	$66.07	$55.17	$47.41	$41.62
3.5%	$90.84	$70.86	$58.18	$49.42	$43.02

DCF Calculator

Company and Assumptions

Projected free cash flow

Where the value comes from

Sensitivity: Value per Share

How a DCF Values a Company

The Formulas

Better DCF Assumptions

Frequently Asked Questions