dcf-modeling

dcf-modeling

When to use

• A buy-build-or-partner decision needs an intrinsic-value anchor, not just a multiple.
• A board pack asks for sensitivity to discount rate or terminal-growth assumptions.
• An acquisition target's seller-deck IRR claims need a counter-model.

Do NOT use for revenue forecasting alone, market-sizing, or comp-multiple-only screens — those route elsewhere (see Related Skills).

Procedure

Step 0: Inspect

1. Confirm the target has ≥3 years of audited or reviewed financials, or a clearly-labelled forecast that names every assumption.
2. Note the cognition cluster: this is intrinsic-value cognition, not multiple-arbitrage.

Step 1: Lock the assumption table

1. Pull or estimate the five drivers — revenue growth (per year, declining to terminal), EBIT margin path, tax rate, capex/sales, change in net working capital/sales.
2. Decompose WACC: cost of equity (CAPM — risk-free + β × ERP), cost of debt (after-tax), capital structure target weights.
3. Pick a terminal-value method once — either Gordon-growth (FCFF_t+1 / (WACC − g)) or exit-multiple. Naming both inflates spurious precision.

Step 2: Project free cash flow

1. Build a 5-year FCFF row: EBIT × (1 − t) + D&A − Capex − ΔNWC.
2. Discount each year by 1 / (1 + WACC)^t.
3. Compute terminal value at year 5, discount back.
4. Sum PV(FCFF) + PV(TV) = enterprise value. Subtract net debt → equity value.

Step 3: Sensitivity grid

1. Build a 5×5 grid: WACC ±200 bps × terminal growth ±100 bps (or exit multiple ±2 turns).
2. Flag the corner cells where equity value flips sign or moves >25% from base — those are the load-bearing assumptions.

Step 4: Validate

1. Cross-check implied EV/EBITDA against trading comps. If your DCF prints 22× and the sector trades at 11×, the assumptions are wrong, not the market.
2. State the two assumptions that drive >50% of the valuation. If you can't name them, the model is undisciplined.

Gotcha

• Terminal value usually carries 60–80% of total PV. Treating TV as a footnote is the most common DCF malpractice.
• WACC sensitivity is non-linear near WACC ≈ g; the Gordon formula explodes. Cap displayed cells; don't pretend the corner is a real number.
• Forecasted FCFF that grows faster than revenue forever implies infinite margin expansion — the model will silently smuggle it in unless you bound EBIT margin at a stated ceiling.
• Synergies in an M&A DCF belong in a separate column. Comingling them with standalone FCFF is how acquirers overpay.