DCF Model Cheat Sheet: Formulas, Steps, and Analyst Tips
The 6 Steps of a DCF Model
| Step | Action | Key Inputs |
|---|---|---|
| 1. Project Revenue | Forecast top-line growth for 5–10 years | Historical growth, industry trends, management guidance |
| 2. Build to Free Cash Flow | Project margins, D&A, CapEx, and working capital | Historical ratios, analyst estimates, industry benchmarks |
| 3. Calculate WACC | Determine the discount rate | Cost of equity, cost of debt, capital structure |
| 4. Discount Projected FCFs | Bring each year’s FCF to present value | FCF ÷ (1 + WACC)^n |
| 5. Calculate Terminal Value | Value all cash flows beyond the projection period | Gordon Growth or Exit Multiple method |
| 6. Sum to Enterprise Value | PV of FCFs + PV of Terminal Value | Bridge to equity value by subtracting net debt |
Free Cash Flow to the Firm (FCFF)
FCFF is the cash available to all capital providers (debt + equity) before any financing decisions. This is what you discount at WACC in a standard DCF.
Weighted Average Cost of Capital (WACC)
WACC blends the cost of equity and after-tax cost of debt, weighted by the company’s target capital structure. It is the discount rate applied to FCFF.
| Component | Definition | How to Estimate |
|---|---|---|
| E/V | Equity weight (market value of equity ÷ total firm value) | Market cap ÷ (Market cap + Net debt) |
| D/V | Debt weight | Net debt ÷ (Market cap + Net debt) |
| Ke (Cost of Equity) | Return required by equity investors | CAPM: Rf + β × (Rm − Rf) |
| Kd (Cost of Debt) | Effective interest rate on borrowings | Interest expense ÷ Average total debt, or yield on traded bonds |
| Tax Rate | Marginal corporate tax rate | Statutory rate or blended effective rate |
Cost of Equity — CAPM
| Input | Typical Source | Common Range |
|---|---|---|
| Risk-Free Rate | 10-year US Treasury yield | 3.5%–5.0% |
| Beta | Regression vs. S&P 500 (2–5 year weekly) or industry median | 0.6–1.8 for most sectors |
| Equity Risk Premium (ERP) | Historical excess returns or survey-based estimates | 4.5%–6.5% |
| Size Premium (optional) | Added for small-cap companies | 1.0%–3.0% |
Terminal Value
Terminal value captures all cash flows beyond your explicit forecast period. In most DCFs, terminal value represents 60–80% of total enterprise value — which is why it demands careful treatment.
| Method | Gordon Growth | Exit Multiple |
|---|---|---|
| Approach | Assumes FCF grows at constant rate forever | Applies a market multiple to final-year metric |
| Key Assumption | Long-term growth rate (g) — typically 2–3% | Exit multiple based on comparable companies |
| Strength | Theoretically pure, self-contained | Grounded in observable market data |
| Weakness | Extremely sensitive to g and WACC spread | Embeds current market sentiment into intrinsic value |
| Best Practice | Use as a cross-check | Use as primary, validate with Gordon Growth |
From Enterprise Value to Share Price
The DCF gives you enterprise value. To get to the implied share price, bridge from EV to equity value.
Sensitivity Analysis
A DCF without a sensitivity table is incomplete. The output is only as good as your assumptions, so always test how valuation changes across key variable ranges.
| Variable Pair | Why It Matters |
|---|---|
| WACC vs. Terminal Growth Rate | The most common sensitivity — small changes in either create large valuation swings |
| Revenue Growth vs. Operating Margin | Tests the impact of different growth/profitability scenarios |
| Exit Multiple vs. WACC | Shows how market sentiment and discount rate interact |
Key Takeaways
- A DCF model discounts projected free cash flows at WACC to estimate intrinsic value.
- FCFF = EBIT × (1 − Tax Rate) + D&A − CapEx − ΔWorking Capital.
- WACC blends cost of equity (via CAPM) and after-tax cost of debt, weighted by capital structure.
- Terminal value (60–80% of total value) can use the Gordon Growth perpetuity or an exit multiple approach.
- Always include sensitivity analysis — the output is assumption-dependent, and a single number conveys false precision.
Frequently Asked Questions
How many years should I project in a DCF?
Most DCFs use a 5- to 10-year explicit forecast period. Use 5 years for mature, stable businesses and up to 10 years for high-growth companies that need more time to reach steady state. The projection period should extend until the company reaches a normalized margin and growth profile.
What discount rate should I use?
If you are discounting FCFF (cash flow to the entire firm), use WACC. If you are discounting FCFE (cash flow to equity only), use the cost of equity. Most sell-side and buy-side DCFs use WACC with FCFF. Typical WACC ranges are 7–12% for US companies.
Why does terminal value represent such a large share of enterprise value?
Terminal value captures the infinite stream of cash flows beyond your projection period. Even though each individual year’s cash flow is small when discounted far into the future, the aggregate perpetuity sum is enormous. This is mathematically unavoidable — it is why getting the terminal growth rate and exit multiple right matters so much.
Should I use the Gordon Growth model or exit multiple for terminal value?
Best practice is to calculate both and cross-check them against each other. The exit multiple method is more commonly used as the primary approach because it is grounded in observable market data (EV/EBITDA multiples from comparable companies). The Gordon Growth model serves as a sanity check.
What are the most common mistakes in DCF models?
The top errors are: using a terminal growth rate above GDP growth, mismatching FCFF with cost of equity (or vice versa), projecting margins that never normalize, ignoring working capital changes, using levered beta without adjusting for different capital structures, and not running sensitivity analysis. Always stress-test your key assumptions before presenting the output.