The idea
A dollar today is worth more than a dollar tomorrow. A DCF model forecasts a company's unlevered free cash flow and discounts it back at the weighted average cost of capital (WACC).
Key steps
Forecast free cash flow for 5 to 10 years, estimate a terminal value, discount everything at WACC, then bridge from enterprise value to equity value.
Terminal value
Most of a DCF's value often sits in the terminal value, calculated with either the perpetuity growth method or an exit multiple.
Common mistakes
Overly optimistic growth, a terminal growth rate above long-run GDP, and mismatched cash flows and discount rates are frequent errors.
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