How-to
How to build a DCF model (step by step)
A DCF (discounted cash flow) model values a company as the present value of the cash it will generate in the future. You build one in four steps: project the company's free cash flow for the next several years, pick a discount rate that reflects how risky those cash flows are, add a terminal value for everything beyond your forecast, then discount each year's cash and the terminal value back to today and add them up. The result is an estimate of enterprise value, which you convert to a per-share fair value. The model is only as good as its inputs, so the real work is defending your growth, margin, and discount-rate assumptions.
By The Brief Equity Team · Published
The four steps of a DCF
- Project free cash flow for a forecast horizon, usually five to ten years, starting from revenue and working down to the cash left after taxes and reinvestment.
- Pick a discount rate that reflects the risk of those cash flows. For a whole-company DCF this is usually the weighted average cost of capital (WACC).
- Estimate a terminal value for the cash beyond your forecast, using either a perpetuity growth rate or an exit multiple on the final year.
- Discount every projected year and the terminal value back to today at your discount rate, then sum them to get enterprise value.
- Subtract net debt and divide by shares outstanding to convert enterprise value into a per-share fair value you can compare to the market price.
The forecast horizon matters less than the honesty of the numbers inside it. Most models run five to ten years, long enough for a company's growth to fade toward a normal rate, short enough that you are not pretending to forecast a decade of detail you cannot see.
Notice how much of the answer lives in the last two steps. For most companies the terminal value is the majority of the total, so a small change in the terminal growth rate or the discount rate can swing the output more than a year of revenue detail. That is worth remembering before you polish the early years.
What assumptions go into a DCF
| Assumption | What it drives | Where to anchor it |
|---|---|---|
| Revenue growth | The size of future cash flows | Recent results, guidance, and the market the company sells into |
| Operating margin | How much revenue becomes profit | Historical margins and a realistic path, not a permanent peak |
| Reinvestment | The capex and working capital growth requires | Past capital intensity and the company's own capex plans |
| Discount rate | How hard future cash is penalized for risk and time | The company's cost of capital, higher for riskier businesses |
| Terminal assumption | The value beyond the forecast window | A modest long-run growth rate or a defensible exit multiple |
A DCF has a reputation for false precision, and the assumption table is why. Each input is a judgment call, and the model multiplies them together. Change revenue growth by two points and margins by one, and the fair value can move by a third. The discipline is to write down why you chose each number, not to chase decimal places.
A useful habit is to sanity-check the assumptions against each other. High growth usually costs more reinvestment, so a model with fast revenue and thin capex is quietly assuming the company gets more efficient every year. If you cannot explain why, the model is telling you something.
How to set a discount rate and terminal value
The discount rate is the return you require for taking on the cash flows' risk. For a whole-company DCF it is usually the weighted average cost of capital, blending the cost of equity and the after-tax cost of debt. Riskier or less predictable businesses warrant a higher rate, which lowers the present value.
The terminal value handles everything past your explicit forecast. Two methods dominate. The perpetuity growth method assumes cash flow grows forever at a modest rate, usually no faster than the long-run economy, since no company outgrows the economy indefinitely. The exit multiple method applies a valuation multiple, often EV/EBITDA, to the final forecast year, as if you sold the business then.
Because the terminal value is often most of the total, treat both inputs with suspicion. A terminal growth rate close to your discount rate produces an enormous, fragile number. If your output only works with a generous terminal assumption, that is the assumption to defend first, not the early-year revenue line.
Building a DCF in Brief Equity
Brief Equity models build a DCF without a spreadsheet. You drive it with your own assumptions, and the valuation recomputes as you drag each one. Base starts on the latest analyst consensus, so you adjust from a real anchor. Keep Bear, Base, and Bull scenarios side by side to compare outcomes.
The output is a DCF per-share value alongside an EV/EBITDA read, so you see two methods at once. From there you can stress the model: a sensitivity view maps fair value across two drivers at the same time, and a Monte Carlo view runs the assumptions many times and plots the full range of outcomes rather than a single point.
None of this replaces the thinking. The tool does the arithmetic and keeps your versions, so the time goes into the assumptions instead of the formulas. Save a snapshot of any version and compare it to an earlier one when your view changes.
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Frequently asked questions
- How many years should a DCF forecast?
- Most DCFs project five to ten years explicitly, then capture the rest in a terminal value. The horizon should be long enough for growth to fade toward a sustainable rate, but not so long that you are inventing detail you cannot support.
- What discount rate should I use in a DCF?
- There is no universal number. For a whole-company DCF the discount rate is usually the weighted average cost of capital, which is higher for riskier or more leveraged businesses. Rather than copy a rate, estimate it from the specific company's cost of equity and debt.
- Why is the terminal value so large in my model?
- For most companies the terminal value is the majority of total value, because it represents all cash flow beyond your explicit forecast. That is normal, but it means small changes in the terminal growth rate or exit multiple move the answer a lot, so those inputs deserve extra scrutiny.
- Do I need Excel to build a DCF?
- No. A spreadsheet works, but a purpose-built tool handles the projection and discounting for you. Brief Equity models build a DCF and an EV/EBITDA model on your own assumptions, recompute as you change inputs, and keep scenarios and snapshots without any formulas.
Brief Equity is built by investors, for investors. For research, not investment advice; market data is delayed. Figures and rules reflect public information at the time of writing and can change. Verify anything time-sensitive at the linked primary source.