Discounted Cash Flow (DCF) Analysis (2024)

Table of Contents
Download Template Key Components of a DCF DCF Methodology Exhibit A – Advantages and Disadvantages Steps in the DCF Analysis Exhibit B – DCF Template Download Template FAQs

The discounted cash flow (DCF) analysis represents the net present value (NPV) of projected cash flows available to all providers of capital, net of the cash needed to be invested for generating the projected growth. The concept of DCF valuation is based on the principle that the value of a business or asset is inherently based on its ability to generate cash flows for the providers of capital. To that extent, the DCF relies more on the fundamental expectations of the business than on public market factors or historical precedents, and it is a more theoretical approach relying on numerous assumptions. A DCF analysis yields the overall value of a business (i.e. enterprise value), including both debt and equity.

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Key Components of a DCF

  • Free cash flow (FCF) – Cash generated by the assets of the business (tangible and intangible) available for distribution to all providers of capital. FCF is often referred to as unlevered free cash flow, as it represents cash flow available to all providers of capital and is not affected by the capital structure of the business.
  • Terminal value (TV) – Value at the end of the FCF projection period (horizon period).
  • Discount rate – The rate used to discount projected FCFs and terminal value to their present values.

DCF Methodology

The DCF method of valuation involves projecting FCF over the horizon period, calculating the terminal value at the end of that period, and discounting the projected FCFs and terminal value using the discount rate to arrive at the NPV of the total expected cash flows of the business or asset.

Exhibit A – Advantages and Disadvantages

AdvantagesDisadvantages
  • Theoretically, the DCF is arguably the most sound method of valuation.
  • The DCF method is forward-looking and depends more future expectations rather than historical results.
  • The DCF method is more inward-looking, relying on the fundamental expectations of the business or asset, and is influenced to a lesser extent by volatile external factors.
  • The DCF analysis is focused on cash flow generation and is less affected by accounting practices and assumptions.
  • The DCF method allows expected (and different) operating strategies to be factored into the valuation.
  • The DCF analysis also allows different components of a business or synergies to be valued separately.
  • The accuracy of the valuation determined using the DCF method is highly dependent on the quality of the assumptions regarding FCF, TV, and discount rate. As a result, DCF valuations are usually expressed as a range of values rather than a single value by using a range of values for key inputs. It is also common to run the DCF analysis for different scenarios, such as a base case, an optimistic case, and a pessimistic case to gauge the sensitivity of the valuation to various operating assumptions. While the inputs come from a variety of sources, they must be viewed objectively in the aggregate before finalizing the DCF valuation.
  • The TV often represents a large percentage of the total DCF valuation. Valuation, in such cases, is largely dependent on TV assumptions rather than operating assumptions for the business or the asset.

Steps in the DCF Analysis

The following steps are required to arrive at a DCF valuation:

  • Project unlevered FCFs (UFCFs)
  • Choose a discount rate
  • Calculate the TV
  • Calculate the enterprise value (EV) by discounting the projected UFCFs and TV to net present value
  • Calculate the equity value by subtracting net debt from EV
  • Review the results

Exhibit B – DCF Template

The following spreadsheet shows a concise way to build a “best-practices” DCF model. Calculation of unlevered cash flow may be modified as warranted by your specific situation. Each of the steps required to conduct a DCF analysis is described in more detail in the following sections. You can download the DCF template below.

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Discounted Cash Flow (DCF) Analysis

Try Macabacus for free to accelerate financial modeling in Excel.

Note that while unlevered free cash flow inputs are hard-coded in blue here, they would normally be linked to income and cash flow statement items in practice.

Discounted Cash Flow (DCF) Analysis (2024)

FAQs

What is a discounted cash flow DCF analysis generally? ›

Discounted cash flow (DCF) refers to a valuation method that estimates the value of an investment using its expected future cash flows. DCF analysis attempts to determine the value of an investment today, based on projections of how much money that investment will generate in the future.

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How do you calculate DCF? ›

The discounted cash flow (DCF) formula is equal to the sum of the cash flow in each period divided by one plus the discount rate (WACC) raised to the power of the period number.

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How to interpret DCF analysis? ›

Understanding DCF Analysis

The DCF is often compared with the initial investment. If the DCF is greater than the present cost, the investment is profitable. The higher the DCF, the greater return the investment generates. If the DCF is lower than the present cost, investors should rather hold the cash.

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What is the DCF model used for? ›

Discounted cash flow (DCF) is a method of valuation used to determine the value of an investment based on its return in the future–called future cash flows. DCF helps to calculate how much an investment is worth today based on the return in the future.

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Why is DCF the best valuation method? ›

DCF Valuation truly captures the underlying fundamental drivers of a business (cost of equity, weighted average cost of capital, growth rate, re-investment rate, etc.). Consequently, this comes closest to estimating intrinsic value of the asset/business. Unlike other valuations, DCF relies on Free Cash Flows.

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What is a good discounted cash flow rate? ›

For SaaS companies using DCF to calculate a more accurate customer lifetime value (LTV), we suggest using the following discount rates: 10% for public companies. 15% for private companies that are scaling predictably (say above $10m in ARR, and growing greater than 40% year on year)

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How to do a DCF step by step? ›

The following steps are required to arrive at a DCF valuation:
  1. Project unlevered FCFs (UFCFs)
  2. Choose a discount rate.
  3. Calculate the TV.
  4. Calculate the enterprise value (EV) by discounting the projected UFCFs and TV to net present value.
  5. Calculate the equity value by subtracting net debt from EV.
  6. Review the results.

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Is DCF the same as NPV? ›

The main difference between discounted cash flow vs. net present value is that net present value subtracts upfront year 0 costs (in actual dollars estimated) from the sum of the present value of the cash flows. The discounted cash flow method doesn't subtract these initial costs that include capital expenditures.

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How do I calculate DCF in Excel? ›

To calculate the DCF in Excel, follow these steps:
  1. Step 1: Organize Your Data. ...
  2. Step 2: Calculate Present Value for Each Cash Flow. ...
  3. =CashFlow / (1 + DiscountRate)^Year. ...
  4. =B2 / (1 + $F$2)^A2. ...
  5. Step 3: Calculate the Present Value of Terminal Value. ...
  6. =TerminalValue / (1 + DiscountRate)^LastYear. ...
  7. Step 4: Sum the Present Values.
Oct 9, 2023

Read On ›
What is the DCF in simple terms? ›

Discounted cash flow (DCF) valuation is a type of financial model that determines whether an investment is worthwhile based on future cash flows. A DCF model is based on the idea that a company's value is determined by how well the company can generate cash flows for its investors in the future.

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Which cash flow to use for DCF? ›

The DCF model relies on free cash flow (FCF), which is a reliable metric that reduces the noise created by accounting policies and financial reporting.

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Does DCF give you enterprise value? ›

Levered DCF: The levered DCF approach calculates the equity value directly, unlike the unlevered DCF, which arrives at the enterprise value (and requires adjustments thereafter to arrive at equity value). Unlevered DCF: The unlevered DCF discounts the unlevered FCFs to arrive at the enterprise value (TEV).

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What is the most important assumption in the DCF? ›

Understanding the 5 Major DCF Assumptions. The five most important DCF assumptions are: (1) Revenue and cost projections, (2) discount rate, (3) terminal value, and (4) growth rates.

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What is the most important factor in the DCF? ›

The first and most important factor in calculating the DCF value of a stock is estimating the series of operating cash flow projections. There are a number of inherent problems with earnings and cash flow forecasting that can generate problems with DCF analysis.

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