A DCF adds up the present value of a few forecast years and of everything after them; most of the value usually sits in the second part.
The DCF in five steps
- Forecast free cash flow for five to ten years, until the business reaches a steady state (Chapter 3).
- Choose the discount rate (Chapter 4).
- Discount each year's cash flow back to the valuation date.
- Add a terminal value for all years after the forecast, also discounted.
- Bridge to equity value by subtracting net debt and other claims (Chapter 2).
FCFF Years 3–7 → Discount at 12.5% → + Terminal value → = Enterprise value → − Net debt → = Equity value
Vardhan's forecast covers five years (Years 3–7). By Year 7 growth has slowed to 8%, so the terminal value at 5% growth is a small further step, not a cliff.
| Vardhan's DCF at a glance | Choice |
|---|---|
| Valuation date | End of Year 2 |
| Forecast | Five years, Years 3–7 (Book 4 base case, extended) |
| Cash flow | FCFF, year-end convention |
| Discount rate | WACC 12.5% |
| Terminal value | Growth 5%; return on new capital 20% |
Discounting the forecast years
Each year's free cash flow is divided by (1 + WACC) raised to the number of years from the valuation date. This book assumes cash arrives at the end of each year; some valuers use mid-year, which raises value slightly.
| ₹ crore | Year 3 | Year 4 | Year 5 | Year 6 | Year 7 | Total |
|---|---|---|---|---|---|---|
| Free cash flow to the firm | 28.7 | 44.3 | 48.7 | 56.4 | 63.9 | |
| Years from valuation date | 1 | 2 | 3 | 4 | 5 | |
| Discount factor at 12.5% | 0.889 | 0.790 | 0.702 | 0.624 | 0.555 | |
| Present value | 25.5 | 35.0 | 34.2 | 35.2 | 35.4 | 165.4 |
In Excel: =FCFF/(1+WACC)^year, or NPV(WACC, range) for the whole row, which assumes year-end cash flows.
The terminal value
The business doesn't stop after Year 7. The terminal value (TV) captures all later years in one number, usually with a constant-growth formula.
| Step | Vardhan |
|---|---|
| NOPAT in Year 8 = Year 7 NOPAT × (1 + 5%) | 84.8 × 1.05 = 89.1 |
| Reinvestment rate = growth ÷ ROIC on new capital | 5% ÷ 20% = 25% |
| FCFF in Year 8 = NOPAT × (1 − reinvestment rate) | 89.1 × 75% = 66.8 |
| Terminal value at end of Year 7 | 66.8 ÷ 0.075 = 890.7 |
| Present value (× Year 7 discount factor 0.555) | 494.3 |
An alternative is an exit multiple (say, EV/EBITDA at the end of Year 7), but it brings today's market mood into a long-term value. Use it as a cross-check.
Vardhan's DCF
| ₹ crore | Amount | Share of EV |
|---|---|---|
| Present value of FCFF, Years 3–7 | 165.4 | 25% |
| Present value of terminal value | 494.3 | 75% |
| Enterprise value | 659.7 | 100% |
| Less: net debt (₹90.0 cr borrowings − ₹45.0 cr cash) | −45.0 | |
| Equity value | 614.7 | |
| Per share (2.0 crore shares) | ₹307 |
Book value of Vardhan's equity is ₹240 crore, so the DCF values the shares at about 2.6 times book: the market for the business, not its balance sheet, drives the value.
How sensitive is it?
Show how value per share changes with the two inputs that matter most: the WACC and the long-term growth rate. Every serious DCF includes a table like this.
| Value per share (₹) | Growth 4% | Growth 5% | Growth 6% |
|---|---|---|---|
| WACC 11.5% | 336 | 361 | 395 |
| WACC 12.5% (base) | 291 | 307 | 329 |
| WACC 13.5% | 255 | 267 | 281 |
| Equity value (₹ crore) | Growth 4% | Growth 5% | Growth 6% |
|---|---|---|---|
| WACC 11.5% | 671 | 721 | 789 |
| WACC 12.5% (base) | 581 | 615 | 658 |
| WACC 13.5% | 510 | 533 | 562 |
Questions from the worksheet: DCF summary
Summarise the DCF of the business you are valuing on one page.
- Forecast years and FCFF in each
- WACC and its main inputs
- Terminal value: growth, reinvestment, implied exit multiple
- Enterprise value; share from the terminal value
- Bridge to equity value and per share
- Sensitivity: value at WACC ±1 and growth ±1
- Sanity checks passed or failed
What to remember
- A DCF = present value of forecast free cash flows + present value of the terminal value.
- Make terminal growth modest and reinvestment consistent with it; check the implied multiple.
- Always show a WACC × growth sensitivity table and run sanity checks.
- Terminal value
- The value of all cash flows beyond the forecast period.
- Discount factor
- 1 ÷ (1 + rate)^years; converts future cash to today's value.
- Reverse DCF
- Working out what assumptions a given price implies.
This article is adapted from the book. Examples marked “Example” use invented names and numbers; company stories are based on public sources listed in the book. Education only: not investment, tax or legal advice.
