A discounted cash flow values a company as the present value of the cash it is expected to generate. You project unlevered free cash flow for five to ten years, discount each year and a terminal value back to today at the weighted average cost of capital, and sum them to an enterprise value. The method is rigorous because it values the business on its own economics rather than on what the market is paying. It is also fragile, because the answer is only as good as the projections and the discount rate behind it.
A DCF has four moving parts. First, project unlevered free cash flow, the cash the business produces after taxes, capital expenditure, and working-capital needs, but before financing. Second, choose a discount rate, the weighted average cost of capital, that reflects the risk of those cash flows. Third, estimate a terminal value for the years beyond the explicit forecast. Fourth, discount everything back to a present value and sum it to enterprise value.
Free cash flow starts from operating earnings, removes taxes, adds back non-cash charges, and subtracts the capital expenditure and working capital the business needs to grow. The forecast should reflect how the company actually operates, not a straight line.
WACC blends the cost of equity and the after-tax cost of debt, weighted by capital structure. For private companies the cost of equity carries additions for size and company-specific risk, which push the discount rate above what a large public comparable would use.
These adjustments are why a private-company DCF cannot simply borrow a public company’s discount rate. Ignoring them overstates value and sets up a process that stalls in diligence.
A DCF is strongest when a business has predictable cash flows and a credible plan, because it values exactly what a buyer underwrites. It is weakest when projections are speculative, which is common for early-stage or fast-changing companies, where small assumption changes swing the answer by multiples.
For that reason a DCF is rarely used alone. It sits alongside comparable company analysis and precedent transaction analysis, with the market methods anchoring the range and the DCF testing whether the price the market implies is supported by the company’s own economics.
A DCF values a company as the present value of the cash it is expected to generate. You project unlevered free cash flow for several years, discount each year and a terminal value back at the weighted average cost of capital, and sum them to an enterprise value. It values the business on its own economics rather than on market multiples.
The discount rate is the weighted average cost of capital, which blends the cost of equity and the after-tax cost of debt. For a private company the cost of equity adds premiums for size and company-specific risk, such as key-person or customer concentration, which push the rate above what a large public comparable would use.
Terminal value captures the cash flows beyond the explicit forecast period. It is estimated either with a Gordon growth model, applying a modest perpetual growth rate, or by applying an exit multiple to the final forecast year. Because it often makes up most of the total value, the assumption deserves careful scrutiny.
A DCF is only as reliable as its projections. For predictable, established businesses it is strong. For early-stage or fast-changing companies, where forecasts are speculative, small assumption changes swing the answer by multiples, so the result is treated as one input alongside market-based methods rather than the answer.
Rarely. In practice a DCF is paired with comparable company analysis and precedent transaction analysis. The market methods anchor the valuation range and the DCF tests whether the price the market implies is supported by the company’s own cash generation.
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