DCF Valuation Calculator

Value a business from its free cash flow: discount the forecast, add a terminal value and work out the value per share.

What it does

Discounted cash flow valuation is the method that asks the plainest question about a business: what will it actually produce, and what is that worth today? Aswath Damodaran, who teaches the subject at New York University, opens his notes on it with the idea that the value of any asset is the present value of the expected cash flows from holding it. A little further on he writes that because cash flows cannot be forecast forever, valuation models estimate a growth period and then add a terminal value to capture everything beyond it.

That structure is what most people picture when they hear the term. There is a forecast period with a cash flow for each year, each one discounted back to today by the discount rate, and then a terminal value that stands in for the long run. Damodaran also sets out the rule that decides the discount rate: the rate has to match the cash flow being discounted, so cash flow to the firm is discounted at the cost of capital and cash flow to equity at the cost of equity. MIT's finance course notes for valuing companies set out the same two approaches and the same treatment of terminal value, whether the business is liquidated at the end of the forecast or grows at a constant rate forever.

The terminal value is where the argument usually starts, because it is where most of the answer comes from. In the worked example below, 78.9 % of the enterprise value sits in it. Damodaran says the same thing in his valuation notes: the bulk of the present value in most discounted cash flow valuations comes from the terminal value, so the assumptions about growth in the high growth period affect the value far less than the terminal assumptions do. That is a warning rather than a flaw, and it is why the sensitivity table on this page exists.

This page runs the model end to end. Give it the first year cash flow, the growth during the forecast, the discount rate, the perpetual growth rate, the length of the forecast, the net debt and the share count. It returns the present value of the forecast, the present value of the terminal value, the enterprise value, the equity value and the value per share.

What the page cannot do is tell you what discount rate or growth rate to use. Those are judgements about the business, and they belong to the analyst. What the page does is make the arithmetic transparent and show how much the answer moves when one input changes, which is the part most spreadsheets hide.

How to use

1. Enter the free cash flow the business expects in year one.
2. Set the growth rate for the forecast period. Keep it to what the business can realistically sustain.
3. Set the discount rate, which is the cost of capital for cash flow to the firm.
4. Set the perpetual growth rate after the forecast. It must stay below the discount rate, and it should not exceed long term economic growth.
5. Choose how many years to forecast, then enter net debt and the share count to turn the enterprise value into a value per share.
6. Read the split between the forecast and the terminal value. If the terminal value carries most of it, test the result with different rates.

Formula

CFt

Free cash flow in year t.

r

Discount rate, the cost of capital that reflects the risk of the cash flows.

g

Growth rate of the cash flow during the forecast.

CFn+1

Cash flow in the first year after the forecast ends.

n

Number of years in the forecast.

The perpetual growth model needs r to be above g, and the difference between the two is what the terminal value divides by, so the answer explodes as they get close. The stable growth rate also cannot exceed the growth rate of the economy, because nothing grows faster than that for ever. Damodaran warns that small changes in the inputs can alter the terminal value dramatically and that it is easy to misuse the model as a piggy bank for a number you already like.

Worked example

Reference table

Limits

• The forecast assumes one constant growth rate, so a business with a lumpy or cyclical cash flow is not represented well.
• The discount rate and the perpetual growth rate are inputs, not results. The page shows the arithmetic, not the judgement behind the numbers.
• No balance sheet is modelled beyond net debt, so working capital, capital spending and acquisitions have to be handled inside the cash flow forecast.
• Cash flow is treated as certain and evenly spread through each year, so no discount for the timing within a year is applied.

Common mistakes

• Setting the perpetual growth rate above the discount rate, which makes the terminal value meaningless and the model fail.
• Using a growth rate for the forecast that the business could not sustain. Damodaran's point is that the high growth assumptions matter less than the terminal ones, but they still have to be defensible.
• Discounting cash flow to the firm at the cost of equity, or the other way round. The rate has to match the cash flow.
• Forgetting net debt when moving from enterprise value to equity value.
• Reading the result as a target price. The number is what the assumptions imply, and the assumptions are yours.

Try it yourself

Quick checks. Answers sit tucked under each question.

Questions

Sources

• Damodaran, NYU Stern: valuation notes, discounted cash flow and terminal value
• MIT OpenCourseWare 15.402: valuing companies, discounted cash flow and terminal values
• Damodaran, NYU Stern: discounted cash flow valuation, the steps

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