What is DCF (Discounted Cash Flow)?

DCF is considered the most theoretically sound valuation methodology because it values a company based on the actual cash it will generate, not on market sentiment or comparable transactions. The process involves projecting free cash flows for 5-10 years, estimating a terminal value (the value of all cash flows beyond the projection period), and discounting everything back to present value using the weighted average cost of capital (WACC).

The terminal value typically accounts for 60-80% of total DCF value, making its assumptions critically important. Two common approaches are the perpetuity growth method (assumes cash flows grow at a constant rate forever) and the exit multiple method (applies an EBITDA multiple at the end of the projection period).

DCF's biggest challenge is sensitivity to assumptions. Small changes in the discount rate, growth rate, or margin assumptions can dramatically shift the output. In interviews, acknowledge this by presenting a range of values rather than a single point estimate, and identify which assumptions have the greatest impact on the result.