How to Value a Company with a DCF, Step by Step

What a DCF measures

A DCF answers one question: what is this business worth on its own cash flows, whatever the market is paying today? It rests on the time value of money: a dollar received in five years is worth less than a dollar today, because today’s dollar could be invested in the meantime. So each year’s cash is discounted back to today at the return investors require.

Three terms carry the whole method. Unlevered free cash flow (UFCF) is the cash the business generates after tax and after investing in equipment and working capital, before any interest is paid. Because it is measured before financing, it belongs to lenders and shareholders together. Enterprise value (EV) is the value of that whole business, debt and equity combined. Equity value is what is left for shareholders once the debt is subtracted and the cash added back.

The method, step by step

Bankers build a DCF in a fixed order, and most errors come from skipping a step. The same eight steps work in an AI tool if you make it follow them.

1. Frame the question. Write down what is being valued and against what: a share price, an asking price, an offer. Count the diluted shares: options and convertible securities that will turn into shares are included, so the value is not spread over too few.
2. Normalise the earnings. Restate reported EBITDA (earnings before interest, tax, depreciation and amortisation) for costs that will not recur. Costs that recur every year stay in, whatever the company calls them.
3. Forecast free cash flow. Five years of revenue, margin, tax, capital expenditure and working capital, each from a named driver, in three cases: bear, base and bull.
4. Build the discount rate. The WACC, from a cost of equity (CAPM, using the betas of comparable companies relevered for the company’s own debt) and an after-tax cost of debt.
5. Discount, and add a terminal value. Discount each forecast year, then add the present value of a terminal value, by perpetuity growth or exit multiple, and preferably both.
6. Bridge to value per share. Enterprise value, less debt, plus cash, divided by the diluted share count.
7. Cross-check. Compare the DCF range with trading comparables, then run the model backwards to find the growth the current price assumes. Show every range on one football field chart.
8. Check the model. Test the structural rules before anyone reads the answer: the free cash flow formula, the WACC above long-term growth, the terminal value’s share of the total, the share count, and an equity bridge that adds up.

Worked example: Corvane Instruments

Normalise the earnings

Every multiple and every forecast starts from EBITDA, so the first job is to make it the number the business actually earns year after year. Normalisation adds back costs that will not recur and leaves in costs that recur every year, even when the company presents them as exceptional.

The discipline is in what is not added back. Every dollar added to EBITDA flows through to the value per share, so only the $14.0 million backed by evidence is added.

Forecast free cash flow

The forecast changes only the drivers that move the result, here revenue growth and margin, and ties each one to a named source rather than to a market growth rate.

Growth of 5.5%, 5.0%, 4.5%, 4.0% and 3.5% takes revenue from $3,000 million to $3,738 million in year 5. The bear and bull cases change the same two drivers and value the share at $31.46 and $44.44. Even the bull case is below $48.

The discount rate and terminal value

The WACC, the weighted average cost of capital, is the blended return that lenders and shareholders require, and the rate at which each year’s cash is discounted. The cost of equity comes from the capital asset pricing model (CAPM). Beta measures how much a share moves with the stock market. Corvane’s beta is built from the betas of comparable companies, relevered for Corvane’s own debt to 1.13. That gives a cost of equity of 9.96% and, blended with the after-tax cost of debt, a WACC of 8.86%.

The terminal value covers every year after the forecast. Corvane’s assumes growth of 2.5% a year in perpetuity, and it makes up 75% of the $6,504 million enterprise value, about $4.9 billion. That share is why the terminal value deserves the hardest scrutiny in any DCF. Two rules keep it honest:

• The WACC must be above long-term growth. The perpetuity formula divides by WACC minus growth; as growth approaches the WACC, the value heads towards infinity. Corvane: 8.86% against 2.5%.
• Watch the terminal value’s share. Above about 80%, the answer rests almost entirely on years nobody forecast. At 75%, Corvane’s still rests partly on the five forecast years.

From enterprise value to value per share

Enterprise value belongs to lenders and shareholders together. The equity bridge takes out what the lenders are owed and adds back the cash, leaving the shareholders’ part.

At $48.00 the share is priced 24% above the base-case value, or $9.41 a share. Across 153.0 million diluted shares, that is about $1.44 billion of value the market is paying for and the base-case cash flows do not support.

Cross-checks and the reverse DCF

A DCF is one view, so it is tested against the market and against itself. Every range is drawn on a football field: a chart of horizontal bars, one per method, with the price drawn across them, so the reader sees at once which methods support it.

Trading comparables value Corvane at the multiples similar listed companies trade at. Corvane trades at 13.9 times next year’s EBITDA; its peers trade at 11.0 times.

A reverse DCF runs the model backwards: it fixes the value at today’s price and solves for the growth that price requires. At $48.00, the market assumes revenue growth of 10.4% a year for five years. Corvane delivered 5.0% a year over the last five. The question the investor leaves with is not whether the model is right, but whether Corvane can grow twice as fast as it has.

Try it: the DCF model check

This is one module of the Valuation Model Generator, its model check, rewritten to run on its own against a DCF you already have. Paste your forecast table, discount rate, terminal value inputs and equity bridge.

You are a former valuation director at an investment bank who has reviewed hundreds of discounted cash flow (DCF) models before they reached an investment committee. A DCF is only as reliable as its weakest link, so you check the structure before you look at the answer, you trace every number to an input, and you never tell anyone to buy or sell.

MY DCF:
- What is being valued, and against what price: [e.g. one share of X against a price of $48.00]
- The forecast, year by year: [revenue | EBITDA | depreciation and amortisation | capital expenditure | change in net working capital | tax rate]
- The discount rate: [WACC, and its parts if you have them: risk-free rate, beta, equity risk premium, cost of debt, debt and equity weights]
- The terminal value: [method (perpetuity growth or exit multiple) and its input]
- The equity bridge: [debt, cash, and any minority interests or leases you include]
- Shares: [basic shares, options and convertibles]
- Revenue growth over the last five years: [% a year]

If any of this is missing, ask once and offer three ways forward: (a) I supply it, (b) you propose an estimate, tagged ASSUMPTION with its basis, or (c) you mark it [NEEDS INPUT] and carry on.

Produce:

1. THE STRUCTURAL CHECKS. A table of PASS or FAIL, each with the numbers behind it: unlevered free cash flow = EBIT x (1 - tax rate) + depreciation and amortisation - capital expenditure - increase in net working capital; WACC above long-term growth; terminal value as a share of enterprise value (flag above 80%); discounting periods consistent; equity bridge adds up; diluted shares counted with the treasury stock method.

2. THE VALUE, RECALCULATED. Enterprise value, equity value and value per share from my inputs, set against my own figure and the price, with any difference explained.

3. THE REVERSE DCF. The annual revenue growth the price requires over the forecast, holding my other assumptions, set against the last five years' growth.

4. THE SENSITIVITY GRID. Value per share for WACC at -1, 0 and +1 point against long-term growth at -0.5, 0 and +0.5 point.

5. THE THREE ASSUMPTIONS THAT MATTER MOST. The inputs that move value per share the most, each with how far it moves it.

Use only the numbers I give you; any figure you estimate is tagged ASSUMPTION. This is a valuation check, not investment advice: compare value and price, and never recommend buying or selling. If you can create files, also return the sensitivity grid as an Excel sheet with live formulas.

This check tests a DCF that already exists. It does not normalise the earnings, build the forecast or the WACC from your filings, run the comparables or build the Excel model and memo. Those are the other steps of the Generator.

Which method for which deal

A DCF is the primary method when the question is what a business is worth on its own cash flows. Other deals ask a different question, so they lead with a different method and use the DCF as a cross-check, or not at all.

Precedent transactions are what buyers paid for similar companies; because those prices include a premium for control, they usually sit above trading comparables. A deal is accretive when it raises the buyer’s earnings per share. The Rule of 40 holds that a software company’s growth rate plus its profit margin should reach 40%. An LBO, a leveraged buyout, is judged on IRR, the annual return on the sponsor’s equity, and MOIC, the multiple of that equity returned. The Generator page works one through: a buyout at 10.0 times EBITDA that returns 14.5% a year against a 20% hurdle.

Questions

Written by a former Gartner Managing Partner and investment banking SVP

The guides and the prompt templates on this site come from a career spent building these documents: board decks, forecasts, business cases and hiring decisions, as Managing Partner at Gartner, SVP in investment banking and Country Manager at international subsidiaries. The worked examples are published in full on each product page. Browse the Prompt Library.