How to walk through a DCF (and the questions that follow)
A discounted cash flow (DCF) values a company as the present value of the cash it will generate. The standard answer: project unlevered free cash flow for 5 to 10 years, estimate a terminal value for everything after that, discount both back at WACC to get enterprise value, then bridge to equity value and divide by diluted shares.
Interviewers then poke at the assumptions: how you get WACC, why terminal value is usually more than half the value, and what happens when inputs change. The questions below cover those follow-ups.
DCF and valuation questions
Basic
What are the main ways to value a company?
A strong answer covers
- Trading comparables
- Precedent transactions
- Discounted cash flow
- Shown together on a football field; may mention LBO analysis
Basic
Walk me through a DCF.
A strong answer covers
- Project unlevered free cash flow for 5–10 years
- Terminal value by perpetuity growth or exit multiple
- Discount at WACC
- Sum to EV, then bridge to equity value and per-share value
Basic
Why do you discount future cash flows?
A strong answer covers
- A dollar today is worth more than a dollar tomorrow
- Money can be invested to earn a return
- Future cash flows are risky
- The discount rate reflects that risk and time
Intermediate
How do you calculate WACC?
A strong answer covers
- Weighted average of cost of equity and after-tax cost of debt
- Cost of equity via CAPM: risk-free rate + beta × equity risk premium
- After-tax cost of debt = rate × (1 − tax rate)
- Weights based on market values
Intermediate
Which valuation method usually gives the highest value, and why?
A strong answer covers
- Precedent transactions, usually
- Include a control premium paid by acquirers
- Can also reflect synergies
- Depends on market conditions; a DCF can be higher with aggressive assumptions
Intermediate
How do you choose comparable companies?
A strong answer covers
- Same industry and business model
- Similar size, growth and margins
- Similar geography and customer base
- Balance between closeness and having enough comps
Intermediate
What's the difference between unlevered and levered free cash flow?
A strong answer covers
- Unlevered FCF is before interest; goes to all capital providers
- Levered FCF is after interest and debt payments; goes to equity
- Unlevered is discounted at WACC, levered at cost of equity
- Unlevered gives EV, levered gives equity value
Intermediate
What happens to a DCF if the terminal growth rate rises from 2% to 3%?
A strong answer covers
- Terminal value rises
- Valuation goes up
- The effect is large because terminal value is most of the value
- Growth should stay below long-run economic growth
Intermediate
How do you get from enterprise value to the implied share price?
A strong answer covers
- Subtract debt, preferred and noncontrolling interest
- Add cash
- That gives equity value
- Divide by diluted shares
Intermediate
What is beta, and how do you get a beta for a private company?
A strong answer covers
- Beta measures sensitivity to the market
- Find comparable public companies' betas
- Unlever them to remove debt effects
- Re-lever at the target's capital structure
Advanced
How would you value a company with negative earnings?
A strong answer covers
- Use revenue multiples or other non-earnings metrics
- DCF with longer projection until cash flows turn positive
- Industry metrics like users or subscribers
- Acknowledge higher uncertainty and use ranges
Advanced
Perpetuity growth vs. exit multiple for terminal value: when do you use each, and how do you check they're consistent?
A strong answer covers
- Perpetuity growth is more theoretical; exit multiple is market-based
- Back out the implied multiple from the growth method and vice versa
- Implied growth should be below long-run GDP growth
- Bankers often show both
Advanced
Why is a standard DCF a poor fit for a bank or an early-stage startup?
A strong answer covers
- Banks: debt is raw material, not financing, so unlevered FCF doesn't apply
- Banks are valued with P/E, P/BV or dividend discount models
- Startups: no stable cash flows; terminal value dominates
- Very sensitive to assumptions
Advanced
Two DCFs of the same company differ by 40%. What would you check first?
A strong answer covers
- Terminal value assumptions: growth rate or exit multiple
- WACC inputs: beta, equity risk premium, capital structure
- Revenue growth and margin projections
- Treatment of working capital, capex, SBC and taxes
Advanced
Two companies have identical cash flows, but one has much more debt. Which likely has the lower WACC, and when does adding debt stop helping?
A strong answer covers
- Up to a point, more debt lowers WACC because debt is cheaper and tax-deductible
- Too much debt raises both the cost of debt and cost of equity
- Eventually WACC rises from distress risk
- Shows the U-shaped relationship
Advanced
When would you use a sum-of-the-parts valuation?
A strong answer covers
- Company has distinct segments with different growth and risk
- Value each segment with its own multiples or DCF
- Add them up, then subtract net debt
- Common for conglomerates and spin-off analysis
Quick quiz (11 questions)
Among the standard valuation methods, which usually produces the highest valuation?
- Trading comps
- Precedent transactions ✓
- 52-week high/low
- Liquidation value
Acquirers pay a control premium, which pushes precedent multiples up.
Unlevered free cash flow is discounted at:
- Cost of equity
- Cost of debt
- WACC ✓
- Risk-free rate
UFCF goes to all capital providers, so it's discounted at the blended WACC.
In most DCFs, the terminal value makes up:
- Under 10% of value
- About 25%
- More than half of value ✓
- None, it's optional
Cash flows beyond the projection period usually drive the majority of value, which is why TV assumptions get scrutinized.
What does a football field chart show?
- A company's share price history over the past year
- Each banker's fee estimate for the deal
- Ranges of value from different methods side by side ✓
- A timeline of the company's debt maturities by year
Bankers compare comps, precedents and a DCF on one chart.
Raising WACC in a DCF makes the valuation:
- Higher
- Unchanged
- Lower ✓
- Negative
A higher discount rate shrinks the present value of future cash flows.
Two companies have the same EBITDA but trade at different EV/EBITDA multiples. The best explanation:
- One of the companies holds more cash
- Differences in growth, margins or risk ✓
- The two companies have different share prices
- The companies use different fiscal years
Investors pay more for faster growth, better margins and lower risk.
If WACC goes up, a DCF valuation:
- Goes up
- Goes down ✓
- Stays the same
- Depends on revenue
A higher discount rate shrinks the present value of future cash flows.
Cost of equity is usually higher than cost of debt because:
- Equity holders are paid last and take more risk ✓
- Debt doesn't charge any interest at all
- Stocks cost less than bonds to issue
- Equity payments are tax-deductible for the company
Equity is riskier, and interest on debt is tax-deductible, making debt cheaper.
What's the formula for enterprise value?
- Equity value + debt − cash ✓
- Equity value − debt + cash
- Revenue × margin
- Net income × P/E
EV adds debt (and similar claims) and subtracts cash to value the whole business.
Why is EBITDA paired with enterprise value rather than equity value?
- It's after interest, so it belongs to shareholders
- It's before interest, so it belongs to all capital providers ✓
- It's a cash number
- It's after taxes, so it only belongs to shareholders and not to lenders
EBITDA is available to both debt and equity holders, like EV.
What does a DCF value?
- The present value of a company's future cash flows ✓
- Only the company's stock price today
- Last year's profit divided by its share count
- The book value of the company's assets
A DCF discounts projected free cash flows back to today.
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Build a DCF in the free DCF builder →More free guides
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