Glossary
Discounted Cash Flow (DCF)
A valuation method that estimates what a business is worth today by discounting its expected future cash flows.
A discounted cash flow model values an investment by estimating the cash it will produce in the future and converting each year's cash into today's money with a Discount Rate. The sum is the estimated Intrinsic value. It rests on the idea that a business is worth exactly the cash it can return to its owners over its life, no more and no less.
How a DCF is built
- Forecast cash flows, usually Free cash flow (FCF), for five to ten years.
- Estimate a terminal value for all the years after that, often by assuming cash flow grows at a modest constant rate forever.
- Choose a discount rate that reflects the riskiness of the cash flows, often the weighted average cost of capital.
- Discount and add everything up, then subtract net debt to get equity value per share.
Why the output is fragile
That last point is typical. Most of a DCF's value often sits in the terminal value, which depends on two guesses, the long-run growth rate and the discount rate. Raise the discount rate in the example from 9% to 10% and the value falls by about 14%, to roughly $1,599m. A DCF is best used to test what a market price implies about growth, or to compare scenarios, rather than as a precise answer.