What you will learn
- Follow the six steps of a complete DCF from cash flows to a per-share value
- Discount a stream of cash flows and a terminal value back to today
- Bridge from enterprise value to intrinsic value per share
- Read a DCF result as a range, not a precise number
You now have all three ingredients: projected cash flows, a discount rate, and a terminal value. This lesson assembles them into a complete valuation, step by step, so the whole process becomes concrete. None of the steps is hard on its own. The skill is stringing them together cleanly and remembering what each number means.
Discounted cash flow analysis, the DCF formula (Corporate Finance Institute)
Walks through the DCF formula and how the pieces connect. A clean reference for the six steps below.
The six steps
- Project free cash flow for the explicit forecast period, say each of the next five years, using assumptions grounded in the company's history and prospects.
- Estimate the discount rate, usually the weighted average cost of capital, reflecting the risk of the cash flows.
- Discount each year's cash flow to present value, dividing each by (1 plus the discount rate) raised to the number of years away it is.
- Calculate the terminal value for everything beyond the forecast, then discount that terminal value back to the present too.
- Sum all the discounted cash flows and the discounted terminal value. This total is the enterprise value, the value of the whole business.
- Bridge to a per-share figure: subtract net debt to get equity value, then divide by shares outstanding to get intrinsic value per share.
Key terms
- Enterprise value
- The value of the whole business, the sum of the discounted cash flows and terminal value. It belongs to all investors.
- Net debt
- Total debt minus cash. Subtracted from enterprise value because lenders have a prior claim.
- Equity value
- Enterprise value minus net debt. What belongs to shareholders.
- Intrinsic value per share
- Equity value divided by shares outstanding. The number you compare to the market price.
A simple DCF from start to finish
A company will produce about 100 of free cash flow each year for three years. Your discount rate is 10 percent. You assume a 2.5 percent perpetual growth rate for the terminal value. It has net debt of 275 and 100 shares outstanding.
- Discount the three cash flows. 100 over 1.10 is 90.9, 100 over 1.21 is 82.6, and 100 over 1.331 is 75.1. Together that is about 248.6.
- Terminal value at end of year 3. 100 times 1.025 divided by (0.10 minus 0.025) is 1,367. Discounted back three years, 1,367 over 1.331 is about 1,027.
- Enterprise value. 248.6 plus 1,027 is about 1,275.
- Bridge to per share. Subtract net debt: 1,275 minus 275 is 1,000 of equity value. Divided by 100 shares, that is 10 per share.
Why it matters: Notice the terminal value, about 1,027, is far larger than the three years of discounted cash flow, about 249. That is the terminal value dominance you were warned about.
From enterprise value to per share
The sum of the discounted cash flows and terminal value gives the value of the entire business, its enterprise value, which belongs to all capital providers. To find what the equity is worth, you subtract net debt, which is total debt minus cash, because lenders have a prior claim. Dividing the resulting equity value by the number of shares outstanding gives the intrinsic value per share, the single number you can finally compare to the market price.
Bridge to value per share
A DCF produces an enterprise value of 1,500. The company has net debt of 300 and 120 shares outstanding. What is the intrinsic value per share?
Discount each year, add a discounted terminal value, subtract net debt, divide by shares. That sequence turns a forecast into a price.
How to build a DCF, step by step (rareliquid)
An ex-JP Morgan analyst builds a DCF from scratch in an approachable way. Watch to see the six steps come to life on a real model.
Reading the result honestly
If your intrinsic value per share comes out well above the market price, the stock may be undervalued. If it comes out well below, it may be overvalued. But resist treating the output as precise. A DCF produces an estimate that depends entirely on your assumptions, and you have seen how sensitive it is to the discount rate and the terminal value. The right way to use the result is as a central estimate surrounded by a range, which is exactly why the next lessons add market-based cross-checks and formal sensitivity analysis. A single DCF number is a starting point for judgment, not the end of it.
The DCF says buy. Now what?
Your DCF gives an intrinsic value of 10 dollars per share and the stock trades at 7. A colleague says, the model says buy, so we should back up the truck. What is the mature response?
A DCF gives a central estimate, not a precise verdict. The mature response is to test the assumptions, cross-check with other methods, and demand a margin of safety before acting.Order the final bridge
Match each figure in the enterprise-to-per-share bridge with what it means.
You can now build a full DCF. But a valuation from the inside can drift from reality if its assumptions are off, so the next lessons add a market-based cross-check: comparable company analysis.