DCF Calculator
Discounted cash flow analysis estimates a company's intrinsic value by projecting future free cash flows and discounting them to present value. Determine whether a stock is trading above or below its fair value.
How DCF Valuation Works Step by Step
DCF analysis follows a logical three-step process. First, project the company's free cash flows for an explicit period, typically 5-10 years. Start with current free cash flow and apply an expected growth rate. A company generating $5 million in FCF growing at 10% annually would produce $5.5 million in year one, $6.05 million in year two, and so on. Second, discount each projected cash flow back to present value using an appropriate discount rate, typically the company's WACC. A cash flow of $6.05 million two years from now at a 12% discount rate has a present value of $4.82 million. Third, calculate the terminal value at the end of the projection period using the Gordon Growth Model: terminal value equals the final year's FCF times (1 plus terminal growth rate) divided by (discount rate minus terminal growth rate). Discount the terminal value to present value and add it to the sum of discounted cash flows. This total represents the enterprise value. Divide by shares outstanding to get fair value per share.
Key Assumptions That Drive DCF Results
DCF accuracy depends entirely on the quality of your assumptions, and three inputs dominate the output. The growth rate during the projection period determines how large cash flows become. Overly optimistic growth rates inflate fair value, so base estimates on historical growth, industry trends, and competitive position rather than wishful thinking. The discount rate reflects the opportunity cost and risk of the investment. Higher discount rates reduce present value, so riskier companies deserve higher rates. Using WACC ensures consistency with the company's actual capital structure. The terminal growth rate is arguably the most critical assumption since terminal value often represents 60-80% of total DCF value. A terminal growth rate above the economy's long-term growth rate is unrealistic since no company can grow faster than GDP forever. Typically 2-3% is appropriate. Changing the terminal growth rate from 2% to 3% can increase fair value by 20% or more, demonstrating the extreme sensitivity of DCF to this single input.
Practical Tips for Better DCF Analysis
Professional analysts employ several practices to make DCF more reliable. Always run sensitivity analysis by varying growth rate, discount rate, and terminal growth rate independently to see how fair value changes. Present results as a range rather than a single point estimate. Use conservative assumptions rather than optimistic ones. If a stock appears undervalued even with conservative inputs, the margin of safety is substantial. Cross-check DCF results against comparable company multiples and precedent transactions. If your DCF says a stock is worth $100 but every comparable company trades at multiples implying $50, examine your assumptions critically. Use free cash flow rather than earnings since cash flow is harder to manipulate through accounting choices. Adjust for net debt by subtracting total debt and adding cash to enterprise value before dividing by shares. Consider multiple scenarios: bull case, base case, and bear case, each with different growth assumptions. The spread between these scenarios indicates the uncertainty in the valuation and helps you decide how much conviction to have.
Frequently Asked Questions
What is a DCF analysis?
DCF analysis estimates a company's value by projecting its future free cash flows, then discounting them back to today's dollars using an appropriate discount rate. The sum of discounted cash flows plus the terminal value gives the company's intrinsic value.
What discount rate should I use?
Use the company's weighted average cost of capital (WACC) as the discount rate. WACC typically ranges from 8-15% depending on the company's risk profile. Higher risk companies require higher discount rates. For rough estimates, 10-12% is a reasonable starting point.
What is terminal value?
Terminal value captures the company's value beyond the explicit projection period. It assumes the company grows at a stable, perpetual rate (typically 2-3%, near GDP growth). Terminal value often comprises 60-80% of total DCF value, so the terminal growth rate assumption is critical.
Why is DCF analysis sensitive to assumptions?
Small changes in growth rate, discount rate, or terminal growth rate dramatically affect the output. A 1% change in the discount rate can shift fair value by 20-30%. This is why DCF is best used with sensitivity analysis across a range of assumptions.
When is DCF analysis most appropriate?
DCF works best for companies with predictable cash flows, like mature businesses, utilities, and consumer staples. It is less reliable for early-stage companies with negative or unpredictable cash flows, where revenue multiples or comparable analysis may be more appropriate.