Valuation
The Discounted Cash Flow Model
A company is worth the cash it will produce, discounted for time and risk. Here is the whole machine.
The DCF is the purest statement of what value means: an asset is worth the present value of the cash it will hand you. Everything else — multiples, comparables — is a shortcut to this. The model has four moving parts: project free cash flow, pick a discount rate, add a terminal value, and bridge from enterprise value to equity value per share. The numbers below are illustrative.
Assumptions
- Revenue growth
- 8% → 4% fading
- EBIT margin
- 20%
- Tax rate
- 25%
- WACC (discount rate)
- 10%
- Terminal growth
- 2.5%
- Net debt
- $200
- Shares outstanding
- 100
Step by step
1. 1 · Project free cash flow
Start from revenue, apply the operating margin to get EBIT, tax it, then add back non-cash charges and subtract reinvestment (capex and working capital). Unlevered free cash flow: . This is the cash available to all capital providers, before financing.
2. 2 · Discount at WACC
A dollar next year is worth less than a dollar today. Discount each year's FCF back to the present at the weighted average cost of capital: , where . The WACC blends the required returns of debt and equity by their weights in the capital structure.
3. 3 · Add terminal value
Most of a company's value lies beyond the explicit forecast. Capture it with the Gordon growth formula: , with . Then discount that terminal value back to today like any other future cash flow. Sanity-check: terminal growth must be below the long-run economy's growth, never above.
4. 4 · Bridge to price per share
Summing the discounted flows and terminal value gives enterprise value. Subtract net debt to reach equity value, then divide by shares outstanding: . The spreadsheet carries every intermediate figure so you can trace the price back to a single assumption and test how sensitive it is.
The spreadsheet
The full model as a table — download it as a CSV to open in any spreadsheet app.
| Line item | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
|---|---|---|---|---|---|
| Revenue | 1000 | 1080 | 1155 | 1224 | 1273 |
| EBIT (20%) | 200 | 216 | 231 | 245 | 255 |
| NOPAT (after 25% tax) | 150 | 162 | 173 | 184 | 191 |
| + D&A | 40 | 43 | 46 | 49 | 51 |
| − CapEx | -60 | -65 | -69 | -73 | -76 |
| − Δ NWC | -15 | -16 | -17 | -18 | -15 |
| Free cash flow | 115 | 124 | 133 | 142 | 151 |
| Discount factor @10% | 0.909 | 0.826 | 0.751 | 0.683 | 0.621 |
| PV of FCF | 105 | 102 | 100 | 97 | 94 |