Valuation · 2026-06-15 · 8 min read
Written and reviewed by Project Financial Advisor · FCA · CGMA · ACMA — Chartered Accountant
DCF Valuation Explained for Founders and Analysts
Understand how a DCF valuation works — free cash flow, WACC, terminal value and the bridge from enterprise value to equity value, explained simply for founders.
A discounted cash flow (DCF) valuation estimates what a business is worth today from the cash it will generate in the future. It is the most defensible valuation method because it values the company on its own economics — the cash it actually produces — rather than a multiple borrowed from other companies. This guide explains every component: unlevered free cash flow, the WACC discount rate, terminal value, and the bridge from enterprise value to equity value, with a worked example.
The core DCF formula
A DCF sums each future year's free cash flow discounted to present value: PV = FCF_n ÷ (1 + WACC)^n. You do this for an explicit forecast period (usually 5–10 years), add a discounted terminal value for everything beyond it, and the total is enterprise value. The further out a cash flow sits, the more the (1 + WACC)^n denominator shrinks it — which is why near-term forecasts matter most.
Step 1 — Project unlevered free cash flow
DCF uses unlevered free cash flow (FCFF) — cash available to all investors before financing. Build it as: EBIT − taxes on EBIT (= NOPAT) + depreciation and amortisation − capital expenditure − increase in working capital. It deliberately excludes interest, because the cost of debt is already captured in the discount rate.
| Line | Amount |
|---|---|
| EBIT | 1,000 |
| Less: tax at 25% | (250) |
| NOPAT | 750 |
| Add: depreciation | 200 |
| Less: capital expenditure | (300) |
| Less: increase in working capital | (50) |
| Unlevered free cash flow | 600 |
Step 2 — Discount at WACC
The discount rate is the weighted average cost of capital (WACC) — the blended return debt and equity investors require. You can enter it directly or build it from CAPM (risk-free rate + β × equity risk premium for the cost of equity, blended with the after-tax cost of debt). A higher WACC means a riskier business and a lower valuation.
Step 3 — Add a terminal value
Most of a company's cash flows lie beyond the forecast window. The Gordon Growth terminal value captures them: TV = FCF in final year × (1 + g) ÷ (WACC − g), where g is the perpetual growth rate. The iron rule: WACC must exceed g, or the formula breaks and implies infinite value. Keep g at or below long-run GDP growth (typically 2–3%). Because terminal value often drives half or more of the answer, always cross-check it against an EV/EBITDA exit multiple.
Step 4 — Bridge enterprise value to equity value
Discounting the forecast FCFs plus the terminal value gives enterprise value (the value of the whole business). To reach equity value — what shareholders own — subtract net debt: Equity value = Enterprise value − debt + cash.
Test the assumptions with sensitivity tables
A single DCF number is a false precision. Because the answer swings hard on WACC and terminal growth, professionals present a two-way sensitivity table — enterprise value across a range of WACC and g — so decision-makers see the plausible range, not one point estimate.
Build a DCF without writing the formulas
DCF strengths and limits at a glance
A DCF's strength is that it values a business on its own fundamentals — the cash it generates — rather than on market sentiment, making it the most rigorous method available. Its weakness is sensitivity: because most value often sits in the terminal value, small changes in WACC or long-term growth swing the answer widely. The remedy is not to abandon the DCF but to present a range via sensitivity tables and cross-check against market multiples.
EasyFinancialModels writes every DCF formula for you: unlevered free cash flow, WACC (entered directly or via CAPM), a Gordon-Growth terminal value with an EV/EBITDA cross-check, the equity bridge, equity IRR and two-way sensitivity tables on WACC and terminal growth — all live in Excel. It is free for a 3-year model, with just your email.
Related: build a DCF in Excel step by step · terminal value methods · DCF valuation model generator
Frequently asked questions
What is a DCF valuation in simple terms?
It values a business as the sum of its future cash flows, each discounted to today because money now is worth more than money later. Add a terminal value and subtract net debt for equity value.
What inputs does a DCF need?
Projected free cash flows, a discount rate (WACC), a terminal growth rate or exit multiple, and net debt. Small changes in WACC and terminal growth move the answer significantly.
Is a DCF better than using multiples?
A DCF is intrinsic and rigorous but sensitive to assumptions; multiples are quick but reflect market mood. Professionals use both and compare the ranges.
→ Build your dcf & valuation model free with the DCF Valuation tool
More DCF & Valuation guides
How to Build a DCF Model in Excel (Step-by-Step Guide) · Hurdle Rate Explained: How to Set the Minimum Return (and Use It with NPV & IRR) · How to Calculate WACC and Cost of Equity (CAPM Formula) · How to Calculate Terminal Value in a DCF (Gordon Growth & Exit Multiple) · Enterprise Value vs Equity Value: The Difference Explained
About the author
Every model is built and reviewed by the project's Financial Advisor — a Fellow Chartered Accountant (FCA) of the Institute of Chartered Accountants of Pakistan (ICAP), Chartered Global Management Accountant (CGMA) and Associate Chartered Management Accountant (ACMA) with around two decades of corporate finance, audit and accounting experience, designing investor-grade financial models across industries. Full credentials and background are available on LinkedIn. More about the author →
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