If you’ve ever Googled “how to value a company,” you’ve probably come across the DCF — or Discounted Cash Flow model. It sounds fancy and intimidating, but once you break it down, it’s just a structured way to figure out what a business is worth based on the cash it could generate in the future.

This guide is for beginners who want to understand not just what DCF is, but how to do it step-by-step — and why each step matters.

Let’s get into it.

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I. What Even Is a DCF?

A DCF is a valuation method used to estimate the value of an investment (like a company) based on its future cash flows.

Imagine someone offers to give you $100 every year for the next 5 years. That money in the future isn’t worth $100 today — because of inflation, opportunity cost, and risk. So you “discount” those future payments to find out what they’re worth today. That’s the essence of DCF.

In finance terms:

DCF = Present value of all future Free Cash Flows (FCFs) + value of the business after the forecast period (called Terminal Value)

II. The 2 Building Blocks of a DCF

There are only two main parts to a DCF:

1. Forecast the cash the company will generate in the future
   Usually for the next 5–10 years (this is called the explicit forecast period).
2. Estimate the value of the company after that
   Since you can’t forecast forever, you summarize the long-term value in a lump sum called the Terminal Value.

Then you discount all those values back to today.

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Step-by-Step DCF Walkthrough

Step 1: Forecast Free Cash Flow (FCF)

We don’t use accounting profit like net income — we use Free Cash Flow, which tells us how much actual cash the company is generating that’s available to investors.

Here’s the formula:

FCF = EBIT × (1 – Tax Rate) + D&A – CapEx – Change in Working Capital

Breakdown:

• EBIT: Operating profit (before interest and taxes)
• Tax Rate: The company’s effective tax rate or average of the tax rates of key countries where the company conducts business
• D&A: Depreciation and amortization (non-cash expenses)
• CapEx: Capital Expenditures (spending on assets like equipment)
• Change in Working Capital: Difference in current assets/liabilities

We do this for each year — e.g., 2025 to 2030

Step 2: Calculate the Terminal Value (TV)

Since we can’t forecast cash flows forever, we summarize the value of all future years after the forecast in a single number: Terminal Value.

There are two common methods:

A. Gordon Growth Model (most common)

Assumes cash flow grows forever at a stable rate:

TV = FCF in final year × (1 + g) / (WACC – g)

Where:

• g = long-term growth rate (usually 1–3%)
• WACC = discount rate (we’ll explain next)

B. Exit Multiple Method

Assumes the company is sold at a multiple of EBITDA:

TV = EBITDA × Multiple (like 10x or 12x)

Step 3: Choose a Discount Rate (WACC)

The discount rate adjusts for the risk of future cash flows. We use something called WACC (Weighted Average Cost of Capital), which blends the cost of debt and equity based on how the company is financed.

You don’t have to be a math whiz here — most companies fall between 7–12%, depending on industry and risk.

For a beginner model, 9% is a good middle ground.

Step 4: Discount Everything to Present Value

Now we calculate what those future FCFs and Terminal Value are worth today. This is where the “discounted” part of DCF comes in.

PV = FCF / (1 + WACC)^t

Do this for:

• Each year’s FCF
• Terminal Value (discounted back as well)

Step 5: Add It All Up

Finally, add together:

Enterprise Value = Sum of discounted FCFs + discounted Terminal Value

Then calculate:

Equity Value = Enterprise Value – Net Debt

And lastly:

Value per Share = Equity Value / Shares Outstanding

Boom — you’ve now estimated what the stock should be worth.

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Final Thoughts: DCF Is a Tool, Not a Truth

A DCF is only as good as your assumptions. If you overestimate growth or underestimate risk, you can make any stock look undervalued. So treat it like a compass, not a crystal ball.

But once you understand how DCF works, you’re no longer just guessing what a stock is worth — you’re thinking like an analyst.

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Download DCF Valuation Excel Template