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A DCF (Discounted Cash Flow) model values a business or investment by summing the present value of all expected future cash flows. It is the foundational valuation methodology in corporate finance.
The DCF formula
Enterprise Value = Σ (FCF_t / (1 + r)^t) + Terminal Value / (1 + r)^n
Where FCF_t = free cash flow in year t, r = discount rate (WACC), n = forecast years.
Terminal Value (Gordon Growth model (which assumes cash flows grow at a constant rate forever)) = FCF_n × (1 + g) / (r − g)
Where g = terminal growth rate (must be < r).
Discount rate guidance
| Company type | Typical discount rate |
|---|---|
| Public large-cap | 8–10% |
| Public mid-cap | 10–14% |
| Private growth stage | 15–25% |
| Early-stage startup | 25–40% |
| Seed / pre-revenue | 40–60% |
The importance of terminal value
In a 10-year DCF, terminal value often accounts for 70–90% of total enterprise value. This makes the terminal growth rate assumption the single most sensitive variable. Small changes in g (terminal growth) produce large changes in value — always sensitise your model.
DCF limitations
DCF is only as good as your cash flow projections. It is most reliable for: - Stable, mature businesses with predictable cash flows - Businesses you can project 5–10 years with reasonable confidence
It is least reliable for: pre-revenue companies, highly cyclical businesses, and companies where intangible value dominates.