Discounted cash flow (DCF)
Discounted cash flow (DCF) is a valuation method that works out what a company is worth today from the money it is expected to generate in the future. Each future cash flow is divided by a discount factor reflecting risk and the passage of time, and the sum of them all is the value of the business. Its strength is that it forces every assumption into the open; its limit is that the result depends entirely on them.
How it is calculated
You project free cash flow for the coming years, bring each year back to today's money by dividing by (1 + WACC) raised to the number of years, and add a terminal value that captures everything after that. With FCF of €100M next year growing at 5 %, a WACC of 9 % and perpetual growth of 2 %, the first five discounted years add up to about €430M. The terminal value, by the Gordon formula —year-6 FCF divided by WACC minus g— comes to €1,860M, and discounted back to today leaves about €1,210M. Total: roughly €1,640M of enterprise value. Subtracting net debt gives the equity value, and dividing by the share count gives the value per share.
The figures in the example are invented and rounded so the arithmetic can be redone by hand. They are not data from any real company.
What it is NOT
It is not a measurement, it is a model, and its result depends entirely on what you feed it. In the example above the terminal value is 74 % of the total: the DCF is mostly telling you what you believe about year six onwards, not about the five years you projected in detail. And it is extremely sensitive: half a point of WACC either way moves the value per share by between 9 % and 16 %. That is why a single-number DCF is useless; what informs is the range between scenarios.
Formula
Valor = Σ FCF₍ₜ₎ ÷ (1 + WACC)ᵗ + valor terminal See also
WACC (weighted average cost of capital) · Free cash flow (FCF) · Terminal value · Three-stage DCF · Mid-year convention
Explained in depth
Where it is used
See it on real data
Celsmar computes this from the accounts companies file with their regulator, and shows which line every figure comes from. Free to start, no card.
Definition for informational purposes. It is not financial advice nor a recommendation to buy or sell.