DCF Analysis Guide

What is DCF?

Discounted Cash Flow (DCF) analysis is a valuation method used to estimate the value of an investment based on its expected future cash flows. The core idea is that money received in the future is worth less than money today.

Core Principle

Value = Sum of all future cash flows, discounted to present value

DCF answers the question: "What is this investment worth TODAY based on what it will generate in the FUTURE?"

Company Valuation

Determine intrinsic value of stocks and businesses

Real Estate

Value rental properties based on expected rent

Project Analysis

Evaluate whether projects are worth pursuing

The DCF Formula

The DCF formula discounts each future cash flow back to today's value using a discount rate that reflects the time value of money and investment risk.

DCF Valuation Formula

DCF = Σ (CF_t / (1 + r)^t)

CF_t = Cash flow in year t r = Discount rate t = Time period (years)

DCF Calculation Steps

1

Project Future Cash Flows

Estimate the cash the investment will generate each year for a forecast period (typically 5-10 years).

2

Determine Discount Rate

Select an appropriate rate based on risk (commonly WACC for companies, or required return for investors).

3

Calculate Present Value of Each Cash Flow

Divide each year's cash flow by (1 + r)^t to get its present value.

4

Calculate Terminal Value

Estimate the value of all cash flows beyond the forecast period.

5

Sum All Present Values

Add all discounted cash flows plus the discounted terminal value.

Choosing a Discount Rate

The discount rate is crucial—it represents the opportunity cost of capital and risk. Higher rates mean future cash flows are worth less today.

Investment Type	Typical Discount Rate	Rationale
Government Bonds	3-5%	Very low risk, guaranteed payments
Blue-chip Stocks	8-10%	Moderate risk, established companies
Growth Stocks	12-15%	Higher risk, uncertain growth
Startups	20-40%	Very high risk, unproven model

Pro Tip: For company valuation, use WACC (Weighted Average Cost of Capital). For personal investments, use your required rate of return.

Terminal Value

Terminal value captures all cash flows beyond your forecast period. It often represents 60-80% of total DCF value, so accuracy is critical.

Gordon Growth Model

TV = CF_n × (1 + g) / (r - g)

Assumes cash flows grow at a constant rate forever. Best for stable, mature businesses.

Example: If Year 5 CF = $100, g = 2%, r = 10%
TV = 100 × 1.02 / (0.10 - 0.02) = $1,275

Exit Multiple Method

TV = EBITDA_n × Multiple

Values the company based on comparable company multiples. Best for acquisitions.

Example: If Year 5 EBITDA = $50, Multiple = 8x
TV = 50 × 8 = $400

Complete DCF Example

Let's value a small business with the following projected cash flows, using a 10% discount rate.

Cash Flow Projections

Year	Cash Flow	Discount Factor	Present Value
1	$50,000	1/(1.10)¹ = 0.909	$45,450
2	$60,000	1/(1.10)² = 0.826	$49,560
3	$70,000	1/(1.10)³ = 0.751	$52,570
4	$80,000	1/(1.10)�?= 0.683	$54,640
5	$90,000	1/(1.10)�?= 0.621	$55,890
Sum of PV (Years 1-5)			$258,110
Terminal	$1,147,500	× 0.621	$712,603
Total DCF Value			$970,713

This business is worth approximately $970,713 based on its expected future cash flows.