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Discounted Cash Flow (DCF) Model
The DCF model values a company based on the present value of its expected future cash flows. It is the most widely used intrinsic valuation method in equity research.
Methodology
Two-stage FCFF
Accuracy
88%
Best for
Cash-rich companies
How It Works
1
Forecast Free Cash Flows
Project the company's Free Cash Flow to Firm (FCFF) for 5 years using revenue growth rates, EBITDA margins, capex, and working capital requirements.
2
Discount to Present Value
Each year's FCFF is discounted to today's value using the Weighted Average Cost of Capital (WACC) with a mid-year convention.
3
Calculate Terminal Value
Beyond the forecast period, we use the Gordon Growth Model: TV = FCFF × (1 + g) / (WACC - g), where g is the terminal growth rate.
4
Build the Equity Bridge
Enterprise Value = PV of cash flows + PV of terminal value. Then subtract net debt to get equity value. Divide by shares outstanding for intrinsic value per share.
Key Formulas
Free Cash Flow to Firm
FCFF = NOPAT + Depreciation - Capex - ΔNWC
Present Value (Mid-Year Convention)
PV = FCFF / (1 + WACC)^(t - 0.5)
Terminal Value (Gordon Growth)
TV = FCFF₅ × (1 + g) / (WACC - g)
Intrinsic Value
IV = (EV - Net Debt + Cash) / Shares Outstanding
When to Use DCF
- Companies with predictable, stable cash flows
- Mature businesses with clear growth trajectories
- Capital-intensive industries (utilities, telecom, manufacturing)
- Comparing intrinsic value vs market price