Walk me through a DCF.
The most common valuation question. They want structure: cash flows, terminal value, discount rate, bridge to equity, sensitivities.
Answer it out loud firstTake 30–60 seconds, as you would in the room. Then compare with the model answer.
Show the model answer
Project the company's unlevered free cash flows for five to ten years, until it reaches a steady state. Estimate a terminal value for everything after, with a perpetuity growth rate or an exit multiple. Discount both to today at the weighted average cost of capital. The sum is enterprise value; subtract net debt and other claims to get equity value, and divide by diluted shares for a value per share. Then test it with sensitivities.
The full answer
- Forecast revenue, margins, tax, capex and working capital, usually five to ten years.
- Unlevered free cash flow each year:
UFCF = EBIT × (1 − tax rate) + D&A − capex − increase in net working capital
- Terminal value at the end of the forecast:
Perpetuity growth: TV = UFCF in year n+1 ÷ (WACC − g)
Exit multiple: TV = EBITDA in year n × EV/EBITDA multiple
- Discount rate: WACC, using a target capital structure at market values.
- Discount each cash flow and the terminal value to today (mid-year convention for the annual flows if appropriate).
- Bridge: EV − net debt − minorities − other claims + non-operating assets = equity value; ÷ diluted shares.
- Sensitise: tables on WACC vs terminal growth (or exit multiple), and on key operating drivers.
Sanity checks
Implied exit multiple vs peers, terminal value as % of EV, growth rate vs long-run GDP.
Mistakes to avoid
Discounting unlevered cash flows at the cost of equity.
Forgetting to discount the terminal value.
Follow-ups they may ask
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