Discounted Cash Flow (DCF) Analysis
Definition
A DCF values a company as the present value of its expected future free cash flows — an intrinsic valuation, independent of current market prices. Standard (unlevered) steps: project unlevered free cash flow for 5-10 years, estimate a terminal value (Gordon growth or exit multiple), discount both at WACC to get enterprise value, then bridge to equity value (subtract net debt, preferred, minority interest) and divide by fully diluted shares.
Discounting uses mid-year convention or year-end convention (mid-year assumes cash flows arrive evenly through the year and gives a slightly higher value); either is acceptable if applied consistently.
Strengths: theoretically grounded, forces explicit assumptions. Weaknesses: extremely sensitive to WACC and terminal-value assumptions (terminal value is often the majority — commonly more than half — of total value), so small input changes swing the answer. Best practice presents a sensitivity table, not a point estimate.
Why interviewers ask
"Walk me through a DCF" is the most important valuation question in any IB interview — you must deliver the full sequence crisply. Traps: forgetting the bridge from enterprise value to equity value, mismatching levered/unlevered cash flows with the discount rate, and being unable to defend terminal-value assumptions.
Related terms
Interviews don't test definitions — they test recall under pressure.
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