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Intermediate · Lesson 6 of 9

Discounted cash flow (DCF) valuation

10 minute read · By Krishna Avadhani, Vestora Academy · Updated 18 October 2026

A DCF values a business as the sum of all future cash flows, discounted back to today. A dollar in ten years is worth less than a dollar now because you could invest today's dollar and because the future is uncertain.

Steps: forecast free cash flow for 5-10 years; estimate a terminal value for all years after that (often with the Gordon growth formula); discount everything at the weighted average cost of capital (WACC); subtract net debt to get equity value; divide by shares outstanding.

DCF results are very sensitive to the discount rate and terminal growth. Changing the discount rate from 8% to 9% can cut the value by 15-20%. Professionals therefore show a range and run scenarios rather than trusting one number. Vestora's Valuation and Forecast tabs show this kind of range.

Formula

Value = Σ FCF_t / (1 + r)^t + TV / (1 + r)^N
Terminal value (Gordon) = FCF_N x (1 + g) / (r - g)

Example: FCF next year $100m, r = 9%, g = 3%: perpetuity value = 100 / 0.06 = $1.67bn.

Key takeaways

  • Value = present value of future cash flows.
  • Terminal value is often most of the total; keep growth assumptions modest.
  • Show a range: small input changes move the answer a lot.

Check your understanding

1. Which change lowers a DCF value?

  • Lower discount rate
  • Higher terminal growth
  • Higher discount rate
  • Higher cash flows
Show the answer

Higher discount rate. A higher discount rate shrinks the present value of future cash.

2. Why should terminal growth be modest (e.g. 2-3%)?

  • Tax law requires it
  • No company can outgrow the economy forever
  • It makes the maths easier
  • Analysts prefer round numbers
Show the answer

No company can outgrow the economy forever. In perpetuity, growth above the economy is impossible.

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General education only, not financial advice. Examples are illustrations. Rules, tax settings and products change; check official sources.