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Formula, calculation and example

Discounted Cash Flow (DCF) Valuation

A Discounted Cash Flow valuation estimates a company's intrinsic value by forecasting future free cash flow and discounting it to today's value. This guide explains the DCF formula, the inputs that matter and a simplified calculation you can reproduce.

DCF formula

FCFF = EBIT × (1 − Tax Rate) + D&A − Capex − ΔNWC; Enterprise value = Σ FCFF_t / (1 + WACC)^t + Terminal value / (1 + WACC)^n

FCFF is unlevered operating cash flow: after-tax EBIT plus depreciation and amortization, less capital expenditure and the change in working capital. Each forecast FCFF is discounted with WACC. The terminal value represents all cash flows after the explicit forecast period. Subtract debt and add cash exactly once after enterprise value, then divide by diluted shares to estimate intrinsic value per share. Levered FCFE must instead be discounted at the cost of equity and is not accepted by this model.

Key inputs

Free cash flow to the firm (FCFF)
Certified unlevered cash flow derived as EBIT × (1 − Tax Rate) + D&A − Capex − ΔNWC from one annual period, reporting currency and unit.
Forecast growth
Expected changes in revenue, margins and reinvestment that determine future free cash flow.
WACC
The weighted average cost of capital used to discount operating cash flows for their risk and timing.
Terminal growth
The sustainable long-term growth rate after the explicit forecast, normally below nominal economic growth.
Net debt
Interest-bearing debt minus cash, deducted from enterprise value to reach equity value.
Diluted shares
The share count including potentially dilutive securities, used to calculate value per share.

Simplified DCF valuation example

  1. 1Assume next year's certified FCFF is $100 million and grows 5% annually for five years.
  2. 2Discount the five annual cash flows at a 9% WACC; their combined present value is approximately $426 million.
  3. 3With 2.5% terminal growth, terminal value at year five is about $1.92 billion and its present value is about $1.25 billion.
  4. 4Add both present values for an enterprise value near $1.67 billion, then subtract $200 million of net debt.
  5. 5Divide the resulting $1.47 billion equity value by 50 million diluted shares.

The simplified DCF produces an intrinsic value of roughly $29.45 per share. Changing WACC or terminal growth can move that estimate substantially, so use a sensitivity range.

When DCF is useful

  • Companies with reasonably predictable and positive free cash flow.
  • Long-term investors who want an intrinsic value estimate instead of relying only on market multiples.
  • Testing how growth, margins and discount rates affect a valuation.

Limitations to consider

  • Small changes in growth, WACC or terminal assumptions can materially change the result.
  • Young, cyclical or unprofitable businesses are difficult to forecast reliably.
  • A DCF should be used as a valuation range rather than a precise price target.

How to calculate DCF

  1. 1Derive FCFF from period-aligned EBIT, tax, D&A, capital expenditure and working-capital data in one reporting currency and unit.
  2. 2Build revenue, margin, tax and reinvestment assumptions for the explicit forecast period.
  3. 3Forecast annual free cash flow from those operating assumptions.
  4. 4Estimate a suitable WACC and a defensible terminal growth rate.
  5. 5Discount forecast cash flows and terminal value to the valuation date.
  6. 6Subtract net debt and divide equity value by diluted shares outstanding.
  7. 7Run sensitivity scenarios for WACC, terminal growth and operating performance.

How to interpret the result

Compare the estimated intrinsic value range with the current market price. A price below the range may indicate a margin of safety, while a price above it may imply optimistic expectations. The quality of the assumptions matters more than false numerical precision.

Compare related stock analysis models

Dividend Discount Model

Value mature dividend payers directly from their expected shareholder distributions.

Relative Valuation

Compare the DCF result with the valuation multiples paid for similar companies.

Monte Carlo Simulation

Explore a distribution of possible price outcomes instead of one base-case forecast.

Frequently asked questions

What does DCF stand for?

DCF stands for Discounted Cash Flow. The method values a business from the present value of its expected future free cash flows.

What is the basic DCF formula?

A DCF adds the present value of forecast free cash flows to the present value of terminal value. Net debt is then deducted and the result is divided by diluted shares.

Is DCF accurate?

A DCF can be useful when assumptions are realistic, but it is highly sensitive to forecasts, discount rates and terminal value. It is best treated as a range rather than an exact answer.

What is WACC in a DCF model?

WACC is the weighted average cost of capital. It represents the blended required return of debt and equity investors and commonly serves as the discount rate.

How much of a DCF should come from terminal value?

There is no universal percentage, but a very high terminal-value share makes the result especially sensitive. Investors should test multiple growth and exit assumptions.

Learn the method in context

Go beyond the formula with worked explanations, assumptions and common mistakes in the Stock Insights Academy.

Read the related Academy guide

Apply DCF to a stock

Use Stock Insights to combine this model with additional valuation and financial health checks.

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