Corporate finance

What is DCF valuation?

DCF discounts future unlevered free cash flows at the cost of capital. This version uses WACC and end-of-year annual FCF to estimate enterprise value.

Definition

DCF discounts future unlevered free cash flows at the cost of capital. This version uses WACC and end-of-year annual FCF to estimate enterprise value.

Intuition

Value comes from explicit yearly cash flows plus a terminal estimate after the forecast. More distant cash flows carry less weight today.

Formula

EV = \sum_{t = 1}^{n} \frac{{FCF}_{t}}{{(1 + WACC)}^{t}} + \frac{{FCF}_{n} (1 + g)}{(WACC - g) {(1 + WACC)}^{n}}

Enterprise value sums discounted forecast FCF and the present value of terminal value. Terminal value grows final-year FCF by (1+g), requiring WACC greater than g.

FCF, WACC, and the forecast period

FCF is cash available to capital providers after operations and needed investment. Here it is unlevered firm FCF. WACC is an annual cost-of-capital discount rate that can draw on cost of equity (often estimated using CAPM) and cost of debt. Enter a percentage; the formula uses a decimal. All FCF occurs at year end.

Terminal value and Gordon Growth

Terminal value represents cash flows after the explicit forecast. Multiply final-year FCF by (1+g) to estimate next-year FCF, divide by WACC−g for value at forecast end, then discount to today. g is a sustainable long-run assumption, not a short-term high-growth rate; WACC must strictly exceed g.

When to use it and limitations

Use it to connect a firm's FCF forecast with its cost of capital and inspect terminal-value dependence. Results are sensitive to FCF, WACC, and g, especially when terminal value dominates. This tool omits net debt, cash, shares, per-share valuation, and a WACC-by-growth sensitivity table. NPV handles general project cash flows; Present Value explains single-payment discounting.

Example

Enter FCF of 100, 110, and 120 for years 1–3, WACC of 10%, and terminal growth of 2%.
Discount each forecast flow by 1.1, 1.1², and 1.1³; together they are worth about 271.98 today.
Grow final-year FCF to 122.4, divide by the 8% WACC-growth spread for a 1,530 terminal value, then discount it and add forecast PV for about 1,421.49 EV.

Common mistakes

Do not extend short-term rapid growth into perpetuity or read EV as stock price. A very narrow WACC-growth spread magnifies terminal value.

Frequently asked questions

Why can terminal value dominate a DCF?

The explicit forecast covers only a finite period; terminal value represents all later cash flows. A high share makes the result especially sensitive to long-run growth and WACC.

Why must WACC exceed terminal growth?

The Gordon Growth formula divides by WACC−g. A zero or negative spread does not produce a meaningful finite terminal value.

Is this a stock price target?

No. This estimates enterprise value only. Equity and per-share values require items such as net debt, cash adjustments, and shares outstanding.