In plain language — A future euro or dollar is worth less than one available today. A DCF estimates what an asset's expected future cash flows are worth now.
DCF is a family of models, not a button that reveals a true price. The analyst projects cash flows that match the valued claim, discounts them at a compatible rate, and adds the value of cash flows beyond the explicit forecast. Because the output depends on assumptions, a sound DCF also presents scenarios and sensitivity.
Building the model
The process starts with the business model. Volume, price, margins, tax, working capital and investment must form a coherent economic story. That story produces free cash flow. Cash flow to the firm leads to enterprise value; cash flow to equity leads directly to equity value. Mixing the cash-flow definition and discount rate breaks the model's logic.
Each projected flow is divided by a discount factor that increases with time and rate. Beyond the explicit period, analysts often estimate a terminal value through perpetual growth or an exit multiple. This component can represent a large share of total value, so normalized margins, growth and the discount rate are central assumptions.
From enterprise value to value per share
When the model uses firm cash flows, operating value is adjusted for cash, debt and other non-operating assets or liabilities to reach equity value. The result is then divided by a consistent diluted share count. The bridge should be visible line by line because capital structure can materially change the amount attributable to shareholders.
Controls and limits
Ask whether forecasts fit capacity and competition, whether reinvestment supports the forecast growth, and whether currency, risk and cash-flow type match the discount rate. Compare margins and returns with history and peers without assuming history must repeat.
Advanced work states the valuation date, currency, timing convention and treatment of leases, tax losses, investments and contingent liabilities. It uses a central case plus motivated alternatives rather than cosmetic decimals. Multiples can expose an inconsistency but cannot replace the model's economic reasoning. The DCF is best understood as a discipline for making assumptions explicit; it does not remove uncertainty and is not financial advice.
Reading the sensitivity table
Do not average every cell. Identify which combinations are economically plausible, explain why the central range was chosen and show the assumptions that would move the company into another part of the table. Sensitivity is a map of uncertainty, not a probability distribution by itself.
Sources
- CFA Institute — Free Cash Flow Valuation — Professional framework for FCFF, FCFE and discounted cash-flow valuation.
- IFRS Foundation — IAS 7 Statement of Cash Flows — Primary reference for cash-flow presentation and classification under IFRS.