DCF Valuation: How to Value a Company from Its Cash Flows
A company's value comes down to the cash it will produce over its lifetime. Those cash flows arrive over many years, and each one is worth less the further out it sits. Discounted cash flow (DCF) valuation accounts for that by projecting future free cash flows, discounting them at the cost of capital, and converting the result into an implied share price.
Key takeaway: A DCF model values a company by projecting its future free cash flows, estimating a terminal value for cash flows beyond the projection period, and discounting everything back to the present at WACC. The output is an enterprise value that you can convert to a share price.
What a DCF Model Does
You project the company's free cash flows for five to ten years. The business doesn't stop at Year 5, so a terminal value captures everything beyond the projection window. Discount the whole stream back to today at the company's weighted average cost of capital (WACC), and the sum is the enterprise value. Subtract net debt, divide by shares outstanding, and you have an implied share price.
The Company
Here is a simplified profile for a mid-size industrial company:
| Amount | |
|---|---|
| Most recent free cash flow | $36M |
| Projected FCF growth (Years 1-5) | 8% per year |
| Terminal growth rate | 3% per year |
| WACC | 10% |
| Total debt | $200M |
| Cash | $47M |
| Shares outstanding | 10,000,000 |
The $36M in free cash flow is the starting point. The company grows FCF at 8% per year during the projection period, then settles into a 3% long-term growth rate after Year 5. For the mechanics of calculating FCF from financial statements, see our guide on free cash flow.
Projecting Free Cash Flow
Growing last year's FCF at 8% per year gives the five-year projection:
| Year | Projected FCF |
|---|---|
| 1 | $38.9M |
| 2 | $42.0M |
| 3 | $45.3M |
| 4 | $49.0M |
| 5 | $52.9M |
Year 1 is $36M x 1.08 = $38.9M. Each subsequent year grows by the same 8%. In a real model, you would project revenue, margins, CapEx, and working capital separately and calculate FCF from those line items. Applying a single growth rate to FCF captures the same idea in fewer steps.
Terminal Value
The projection covers five years, but the company keeps generating cash after that. Terminal value captures the value of all cash flows from Year 6 onward. The most common approach is the perpetuity growth method, which applies the Gordon Growth formula to free cash flow:
Terminal Value = FCF5 x (1 + g) / (WACC - g)
Using the Year 5 FCF of $52.9M, a 3% terminal growth rate, and a 10% WACC:
Terminal Value = $52.9M x 1.03 / (0.10 - 0.03) = $778M
That $778M is the value of all cash flows from Year 6 onward, measured at the end of Year 5. It still needs to be discounted back to the present.
The terminal growth rate should stay close to GDP growth or inflation. Push it too high and you inflate the entire valuation, since terminal value typically dominates the total.
Discounting to Enterprise Value
Now discount each projected FCF and the terminal value at the 10% WACC:
| Year | Projected FCF | Discount Factor (10%) | Present Value |
|---|---|---|---|
| 1 | $38.9M | 0.909 | $35.3M |
| 2 | $42.0M | 0.826 | $34.7M |
| 3 | $45.3M | 0.751 | $34.1M |
| 4 | $49.0M | 0.683 | $33.5M |
| 5 | $52.9M | 0.621 | $32.8M |
| 5 (Terminal) | $778M | 0.621 | $483M |
Enterprise Value = PV of Projected FCFs + PV of Terminal Value
Enterprise Value = $170M + $483M = $653M
The terminal value contributes $483M of the $653M total, roughly 74%. This is typical. Most of a company's value in a DCF model comes from cash flows far in the future, which is why the terminal growth rate and discount rate carry so much weight.
From Enterprise Value to Share Price
Enterprise value captures the value of the entire business, including both equity and debt claims. To isolate what the equity is worth, subtract net debt (total debt minus cash):
| Step | Amount |
|---|---|
| Enterprise Value | $653M |
| Subtract: Net Debt ($200M - $47M) | -$153M |
| Equity Value | $500M |
| Shares Outstanding | 10,000,000 |
| Implied Share Price | $50 |
That $50 is the implied share price. Compare it to the market price and you have a view on valuation: a stock trading below that level looks undervalued on these assumptions, while one trading above it looks overvalued.
For a closer look at the EV-to-equity bridge and why enterprise value strips out the effects of capital structure, see our guide on enterprise value.
How the Assumptions Move the Price
Small changes in WACC or the terminal growth rate shift the implied share price significantly.
Hold the FCF projections constant and vary WACC and the terminal growth rate:
| g = 2% | g = 3% | g = 4% | |
|---|---|---|---|
| WACC = 9% | $52 | $61 | $74 |
| WACC = 10% | $44 | $50 | $59 |
| WACC = 11% | $37 | $42 | $48 |
The center cell is the base case ($50). Moving one percentage point in either direction on WACC shifts the price by $7 to $15, depending on the growth rate. Changing the terminal growth rate by one point has a similar effect.
The widest gap in the table runs from $37 (high WACC, low growth) to $74 (low WACC, high growth), a 2x difference driven by just two percentage points of change in each assumption. This is why analysts present DCF results as a range rather than a single number, and why they cross-check the output against other valuation methods.
Why DCF Matters
DCF is the standard intrinsic valuation method across corporate finance:
- Equity research: Analysts build DCF models to set price targets and issue buy or sell recommendations.
- Mergers and acquisitions: Both buyers and sellers use DCF to anchor negotiations around a fundamental value rather than relying solely on market pricing.
- Capital budgeting: A DCF applied to a single project rather than a whole company is just an NPV calculation with the same mechanics.
- Investment banking: Pitch books and fairness opinions almost always include a DCF analysis alongside comparable company analysis.
The model forces you to state your assumptions explicitly: growth rate, margins, capital spending, discount rate. Even when the final number is imprecise, building the model reveals which variables matter most to the company's value.
Conclusion
DCF ties together free cash flow, terminal value, WACC, and the enterprise-value-to-equity bridge into one model. The implied share price that falls out depends heavily on the discount rate and terminal growth rate, which is why a range of scenarios is more useful than any single number.
For the cash flow inputs that feed a DCF model, see our guide on free cash flow. For the discount rate, see our guide on WACC. For the bridge from enterprise value to equity value, see our guide on enterprise value. For the math behind discounting, see our guide on time value of money.
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