Steps to Create a DCF (Discounted Cash Flow)
1. Project cash flows over 5 or 10 years:
• Calculate unlevered free cash flow (UFCF):
UFCF = EBIT × (1 − Tax Rate) + D&A − CapEx − ∆Working Capital
where:
– EBIT: Earnings before interest and taxes (from Income Statement).
– D&A: Depreciation and amortisation (non-cash expense).
– CapEx: Capital expenditures (investments in assets).
– ∆ Working Capital: Change in current assets minus liabilities.
• Use tools like Capital IQ for financial data.
2. Calculate WACC (Weighted Average Cost of Capital):
E D
WACC = · re + · rd · (1 − t)
E+D E+D
where:
• E: Market value of equity, D: Market value of debt.
• re : Cost of equity (use CAPM: re = rf + β(rm − rf )).
• rd : Cost of debt (average interest rate on debt).
• t: Corporate tax rate.
3. Use WACC to calculate the terminal value:
FCFfinal year × (1 + g)
Terminal Value =
WACC − g
where:
• FCFfinal year : Free cash flow in the last forecast year.
• g: Long-term growth rate (e.g., tied to GDP or inflation).
Terminal value represents the company’s value beyond the projection period and is a significant
component of the DCF.
4. Discount the unlevered FCF to present value using WACC:
n
X FCFt
PV of FCF =
t=1
(1 + WACC)t
Terminal Value
PV of Terminal Value =
(1 + WACC)n
Combine the present value of projected UFCFs and the terminal value to get the total present value.
5. Work out the enterprise value:
Enterprise Value (EV) = PV of FCFs + PV of Terminal Value
EV is the total value of the company’s operations, independent of its financing structure.
6. Calculate equity value:
Equity Value = Enterprise Value − Net Debt
where:
Net Debt = Total Debt − Cash
Divide equity value by the number of shares outstanding to calculate the implied stock price:
Equity Value
Implied Stock Price =
Shares Outstanding
