Walk Me Through a DCF

"Walk me through a DCF" is the single most common technical question in investment banking interviews, and a strong answer is a tight five-step story: project unlevered free cash flow for five to ten years, discount it at WACC, add a terminal value for everything beyond the forecast, sum to enterprise value, then bridge to equity value by subtracting net debt. A DCF values a company on the cash it will generate, discounted to today, so its output is an intrinsic value independent of where comparable companies trade. Interviewers listen for structure first and detail second, so lead with the framework and fill in mechanics only when asked. Deliver it in under ninety seconds.

TL;DR

• A DCF discounts projected unlevered free cash flow at WACC; per CFI the standard forecast is about 5 years.
• The five steps: project FCF, discount at WACC, add terminal value, sum to enterprise value, bridge to equity value.
• Unlevered FCF starts from EBIT: tax it, add D&A, subtract capex and the change in working capital.
• Terminal value (Gordon growth or exit multiple) often drives 60 to 80 percent of the total DCF value.
• Subtract net debt from enterprise value to get equity value, then divide by shares for a price per share.

What is a DCF?

A discounted cash flow analysis values a company based on the cash it will generate in the future, discounted back to today. Wall Street Prep frames the core idea as "a company's intrinsic value is equal to the sum of the present value of its projected free cash flows." A dollar earned in five years is worth less than a dollar today, so you discount each future cash flow by a rate that reflects its risk. Because a DCF is built from the company's own fundamentals, it produces an intrinsic value that does not depend on where comparable companies happen to be trading, which is its main advantage over a multiples-based valuation.

What are the five steps of a DCF?

The clean answer is a five-step sequence you can recite from memory. Each step has one job, and naming them in order signals that you understand the model end to end rather than a list of disconnected formulas.

1. Project unlevered free cash flow over an explicit forecast period, usually five to ten years.
2. Discount those cash flows to the present using the weighted average cost of capital (WACC).
3. Calculate a terminal value to capture all cash flows beyond the forecast period.
4. Discount the terminal value to today and add it to the discounted cash flows to get enterprise value.
5. Bridge from enterprise value to equity value by subtracting net debt.

Corporate Finance Institute compresses the whole thing into one sentence: "build a 5-year forecast of unlevered free cash flow based on reasonable assumptions, calculate a terminal value with an exit multiple approach, and discount all those cash flows to their present value using the company's WACC."

How do you project unlevered free cash flow?

You build unlevered free cash flow from operating profit, not net income, because you want the cash available to every capital provider before financing. Per CFI, the build is "take EBIT, less capital expenditures, plus depreciation and amortization, less any increases in non-cash working capital." In practice you tax EBIT first to reach net operating profit after tax, then add back non-cash charges and subtract reinvestment.

$FCF = EBIT \times (1 - T) + D\&A - CapEx - \Delta NWC$

EBIT is operating profit, T is the tax rate, D&A is depreciation and amortization (a non-cash charge you add back), CapEx is capital expenditure, and the change in net working capital captures cash tied up in operations. You use unlevered free cash flow because it strips out interest, keeping the analysis capital-structure neutral so the result is enterprise value rather than equity value.

Why do you discount at WACC?

You discount unlevered free cash flow at WACC because that cash belongs to every capital provider, so it has to be discounted at the blended return every provider requires. WACC is the weighted average of the after-tax cost of debt and the cost of equity, with weights set by the target capital structure. The present value of the explicit cash flows plus the terminal value is:

$PV = \sum_{t=1}^{n} \frac{FCF_t}{(1 + WACC)^t} + \frac{TV}{(1 + WACC)^n}$

If you discounted unlevered cash flow at the cost of equity alone, you would apply only the shareholders' required return to money that also belongs to lenders, which overstates the discount and understates value. The numerator and denominator have to match: cash to all investors, discounted at the cost of capital to all investors. For the full derivation see WACC explained.

How do you calculate terminal value?

Terminal value captures every cash flow beyond the final forecast year, since you cannot project forever, and it usually drives the majority of a DCF's output. There are two standard methods, and most bankers compute both and sanity-check one against the other. The Gordon growth (perpetuity growth) method assumes cash flows grow at a constant rate forever, using a rate per WSO "typically based on the rate of GDP or inflation (i.e. 1% to 3%)":

$TV = \frac{FCF_n \times (1 + g)}{WACC - g}$

The exit multiple method applies a market multiple, most often EV/EBITDA, to the final-year metric, and CFI notes it is "more common in investment banking." Whichever you use, remember the terminal value is itself a future amount, so you discount it back to today by dividing by one plus WACC to the power of the final forecast year.

DCF input	What it is	Typical source or range
Forecast period	Years of explicit FCF projection	5 to 10 years (CFI: about 5)
Discount rate	Blended required return	WACC for unlevered FCF
Perpetuity growth (g)	Long-run FCF growth rate	1 to 3 percent (GDP/inflation)
Exit multiple	Multiple on final-year metric	EV/EBITDA of comparables
Terminal value share	TV as a fraction of total value	Often 60 to 80 percent

How do you get from enterprise value to equity value?

You sum the discounted cash flows and the discounted terminal value to get enterprise value, then subtract net debt to reach equity value. Net debt is total debt minus cash, and you subtract it because debt holders are paid before shareholders. You also remove other non-equity claims such as preferred stock and noncontrolling interest if they exist. Dividing the resulting equity value by diluted shares outstanding gives an implied share price you can compare to the market price. This bridge is the same one used across valuation methods, so it pays to know it cold; the full mechanics are in enterprise value vs equity value.

Frequently Asked Questions

Why do you use unlevered free cash flow in a DCF?

Unlevered free cash flow is the cash available to all capital providers before any financing decisions, so it keeps the valuation capital-structure neutral. Because the cash belongs to both debt and equity holders, you discount it at WACC and the result is enterprise value. If you used levered free cash flow instead, you would discount at the cost of equity and arrive directly at equity value.

What is the biggest weakness of a DCF?

A DCF is extremely sensitive to its assumptions, especially the terminal value and the discount rate. Terminal value often drives 60 to 80 percent of the total output, so a small change in the perpetuity growth rate or exit multiple can swing the valuation materially. That sensitivity is why bankers run sensitivity tables and cross-check the DCF against comparable company analysis rather than trusting a single point estimate.

How long should the forecast period be?

The explicit forecast period typically runs five to ten years, and CFI's default answer is about five. You forecast far enough out that the business reaches a steady, normalized state, then capture everything after that in the terminal value. High-growth companies sometimes need a longer window so their growth has time to mature before the perpetuity assumption kicks in.

What discount rate do you use for levered free cash flow?

For levered free cash flow you discount at the cost of equity, not WACC, because levered cash flow is what remains after interest and belongs only to shareholders. WSO frames it as FCFF discounted at WACC versus FCFE discounted at the cost of equity. Matching the cash flow to the right discount rate is the single most common DCF mistake interviewers probe.

What is the mid-year convention?

The mid-year convention assumes cash flows arrive in the middle of each year rather than at year end, since a company generates cash throughout the year. It discounts each period by half a year less, which raises the present value slightly. It is a refinement, not a core step, so mention it only if the interviewer asks for added precision.

How does WACC connect to the rest of the model?

WACC is the discount rate that ties the whole DCF together, blending the cost of equity (from CAPM) with the after-tax cost of debt, weighted by capital structure. Raising WACC lowers both the discounted cash flows and the terminal value, so the valuation is highly sensitive to it. The full build, including how to estimate each input, is covered in WACC explained and cost of equity and cost of debt.

Sources

• Corporate Finance Institute, "Walk Me Through a DCF": https://corporatefinanceinstitute.com/resources/career/walk-me-through-a-dcf/ (checked June 2026)
• Wall Street Prep, "Walk Me Through a DCF": https://www.wallstreetprep.com/knowledge/walk-me-through-dcf/ (checked June 2026)
• Wall Street Oasis, "Walk Me Through a DCF Analysis": https://www.wallstreetoasis.com/resources/interviews/walk-me-through-a-dcf (checked June 2026)
• Financial Edge, "Walk Me Through a DCF (5 Steps)": https://www.fe.training/free-resources/financial-modeling/walk-me-through-a-dcf-5-steps/ (checked June 2026)