What a DCF is (intrinsic value, not market price)
A discounted cash flow (DCF) estimates intrinsic value by projecting free cash flows and discounting them back to today.
DCF is an assumptions-driven model. It turns a story about future cash flows into a present value estimate.
A basic DCF has two parts: (1) discounted cash flows in the explicit forecast period, and (2) discounted terminal value after that period.
Small changes in discount rate or terminal growth rate can produce large valuation swings, so sensitivity matters.
- Inputs: initial free cash flow, growth assumptions, forecast years, terminal growth, discount rate.
- Outputs: intrinsic value (and optionally per-share value if shares are provided).
Try it
DCF is a present-value model: cash flows → discount → intrinsic value.
Forecast period: project free cash flows
The explicit forecast period models year-by-year cash flows (often 3–10 years) before switching to a steady terminal assumption.
A longer forecast period shifts value from the terminal value bucket into explicit cash flows.
Forecast growth rate should reflect realistic business dynamics. Extremely high growth assumptions can inflate valuations.
If your cash flow base is small or volatile, sensitivity analysis becomes even more important.
- Try changing forecast years and see how the split between explicit PV and terminal PV changes.
Try it
Forecast years changes the mix: explicit PV vs terminal PV.
Terminal value: why it often dominates
Terminal value represents cash flows beyond the forecast horizon; in many models it is the majority of intrinsic value.
A common approach assumes a stable terminal growth rate (often near long-run GDP/inflation, depending on context).
Terminal growth must be lower than the discount rate; otherwise the math breaks and the implied value becomes unbounded.
If terminal value share is extremely high, your valuation is heavily dependent on long-run assumptions.
- Raise terminal growth slightly (while keeping it below discount rate) and note how intrinsic value can jump.
Try it
If terminal value dominates, your valuation is highly assumption-sensitive.
Sensitivity: discount rate and terminal growth
DCF is fragile: small changes in discount rate or terminal growth rate can shift intrinsic value dramatically.
Discount rate reflects risk and opportunity cost (often tied to WACC in corporate finance).
Use a valuation band instead of a single point estimate when communicating results.
If you have shares outstanding, convert total intrinsic value into intrinsic value per share for comparison against market price.
- Try increasing the discount rate by 1–2% and observe how the value range changes.
Try it
DCF should be communicated as a range, not a single number.
FAQs
What is a DCF valuation?
▾
What is a DCF valuation?
▾DCF (discounted cash flow) valuation estimates intrinsic value by projecting future free cash flows and discounting them back to present value using a discount rate.
Why does terminal value matter so much?
▾
Why does terminal value matter so much?
▾Terminal value represents all cash flows beyond the explicit forecast period. Because it covers many future years, it often accounts for a large share of intrinsic value.
Why must terminal growth be less than the discount rate?
▾
Why must terminal growth be less than the discount rate?
▾In the Gordon growth terminal value formula, the denominator is (discount rate − terminal growth). If terminal growth is greater than or equal to the discount rate, the model breaks mathematically.
Is a DCF valuation precise?
▾
Is a DCF valuation precise?
▾No. DCF is highly sensitive to assumptions. It is best used to understand what a business would be worth under a range of plausible scenarios, not as a guaranteed price target.
Should I use DCF per share or total value?
▾
Should I use DCF per share or total value?
▾Use total intrinsic value to understand enterprise/equity scale, and per-share intrinsic value (when shares outstanding are known) to compare against the market price per share.