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Discounted cash flow (DCF) estimates what an asset or business is worth today by converting its expected future cash flows into present value. A useful DCF is not a precise fact or a price target: its result depends on the cash-flow forecast, discount rate, forecast horizon, and terminal value. This guide explains how to choose those inputs, build a spreadsheet model, and test how the estimate changes when assumptions change.
What discounted cash flow means
The idea behind discounted cash flow is the time value of money: a dollar expected in the future is worth less today because it could have been invested in the meantime, and because future cash flows are uncertain. DCF estimates intrinsic value as the present value of expected future cash flows. The general discounted cash flow formula is:
V₀ = Σ[t=1…n] CFₜ / (1 + r)ᵗ
Here, V₀ is value today, CFₜ is the cash flow expected in period t, r is the discount rate per period, and n is the number of forecast periods. For a business expected to continue operating after the explicit forecast, the calculation also needs a terminal value for cash flows beyond year n. CFA Institute’s 2026 Free Cash Flow Valuation curriculum describes DCF as valuing a security through the present value of its expected future cash flows (CFA Institute curriculum).
Choose the cash flow and the value you want
A DCF model must match its cash-flow stream to its discount rate and valuation target. The two common free-cash-flow approaches are FCFF and FCFE.
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| Approach | Cash flow represents | Discount rate | Value estimated |
|---|---|---|---|
| FCFF | Cash available to all capital providers, before payments to debt and equity holders | Weighted average cost of capital (WACC) | Firm or enterprise value |
| FCFE | Cash available to common equity holders after debt-related cash flows | Required return on equity | Equity value |
If you discount FCFF at WACC, the result is firm value, not the value of common shares. To estimate equity value, subtract debt and account for other non-common capital and non-operating items where relevant. Divide the resulting equity value by diluted shares outstanding only after making that bridge. With FCFE discounted at the required return on equity, the calculation directly estimates equity value.
Building FCFF or FCFE
Do not treat net income or a headline earnings figure as free cash flow without adjustments. Common constructions in the CFA Institute curriculum include:
- Starting with net income: FCFF = NI + NCC + Interest × (1 − tax rate) − FCInv − WCInv.
- Starting with net income: FCFE = NI + NCC − FCInv − WCInv + net borrowing.
- Starting with cash flow from operations: FCFF = CFO + Interest × (1 − tax rate) − FCInv.
- Starting with cash flow from operations: FCFE = CFO − FCInv + net borrowing.
NI is net income, NCC is noncash charges, FCInv is fixed-capital investment, WCInv is investment in working capital, and net borrowing is borrowing less repayment. Apply the company’s accounting classifications consistently: for example, determine how interest and leases are treated, then use the same definitions in both historical figures and forecasts.
When a dividend model may fit better
A dividend discount model (DDM) may be a better fit when a company pays dividends under a discernible policy tied to profitability and the valuation is from a minority investor’s perspective. FCFF or FCFE can be more useful when a company does not pay dividends, dividends differ substantially from its capacity to pay, or the question concerns control of the business. CFA Institute discusses these distinctions in its 2026 Discounted Dividend Valuation curriculum (CFA Institute curriculum).
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How to calculate DCF: a practical sequence
A DCF is easiest to review when each forecast follows from visible operating and financing assumptions rather than from an unexplained growth rate.
- Define the target. Decide whether you need firm value or equity value, then choose FCFF/WACC or FCFE/required return on equity accordingly.
- Set the forecast period. Forecast explicitly for long enough to represent the company’s transition toward a more stable operating state. The period should reflect how far revenue, margins, investment, or working-capital needs can be forecast with reasonable support; there is no universal number of years.
- Forecast operating drivers. Estimate revenue, margins, taxes, noncash charges, capital expenditure, and working-capital investment. Convert those assumptions into FCFF or FCFE using a consistent definition.
- Select a discount rate that matches the cash flow. Use WACC for FCFF and the required return on equity for FCFE. Keep the rate’s time period consistent with the cash-flow periods.
- Estimate terminal value. Choose a perpetual-growth method or an exit multiple, make the assumption explicit, and check whether the result is economically plausible.
- Discount each period’s cash flow and terminal value. Apply the same timing convention throughout, then add the present values to get the relevant firm or equity value.
- Run sensitivities and cross-check. Recalculate using alternative discount rates and terminal assumptions, and compare the result with another valuation method such as market multiples.
Set the discount rate and terminal value
Discount rate: WACC or required return on equity
WACC represents the blended required return of a company’s financing providers and is used with FCFF. FCFE is discounted at the required return on equity because it represents cash available to common equity. Using an equity return with FCFF, or WACC with FCFE, mismatches the cash-flow stream and rate. A rate that is too low increases present value; a rate that is too high reduces it, so the choice should be explained rather than adjusted simply to obtain a preferred answer.
Terminal value using perpetual growth
For FCFF, the perpetual-growth terminal value at the end of year n is:
TVₙ = FCFₙ × (1 + g) / (WACC − g)
g is the assumed long-run annual growth rate. It must be below WACC, and it should be defensible as a sustainable rate for the business over the long run. This method assumes cash flows eventually grow at a stable rate indefinitely. Using a high growth rate close to WACC can make the denominator very small and the resulting terminal value exceptionally large.
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Terminal value using an exit multiple
An exit-multiple method applies a selected market multiple to a terminal-year metric, such as EBITDA. The multiple may be informed by comparable companies or transactions, but it is not automatically correct because it reflects market conditions and comparability assumptions. Perpetual growth makes the long-run growth assumption explicit; an exit multiple makes the assumed market valuation explicit. Consider whether either assumption fits the business and its expected condition at the end of the forecast.
Terminal value represents cash flows beyond the explicit forecast and can account for a large share of modeled value. Discount it back to today using the same timing convention as the forecast cash flows; do not add the terminal value at its year-end amount as though it were already worth that amount today.
DCF formula in Excel
For equally spaced annual cash flows, a basic spreadsheet layout can use years in columns and assumptions in separate cells:
| Row | Example contents |
|---|---|
| 1 | Year 1, Year 2, …, Year n |
| 2 | Forecast FCFF or FCFE for each year |
| 3 | Discount rate per year |
| 4 | Present value of each cash flow: cash flow for year t divided by (1 + rate)^t |
| 5 | Terminal value in year n, then its present value |
For instance, if forecast FCFF is in cells B2:F2 and annual WACC is in B3, the present value of the five forecast cash flows can be calculated with =NPV(B3,B2:F2). Add the terminal value to the final forecast-year cash flow before applying NPV, or discount the terminal value separately by the same number of periods and add it to the present value of the forecast cash flows. Do not include a time-zero investment in Excel’s NPV range: for a project NPV, keep the initial outlay separate and add it to the discounted future cash flows.
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Excel’s ordinary NPV assumes equally spaced periods and a rate corresponding to each period. If cash-flow dates are irregular, use a time-adjusted approach such as XNPV with the actual dates, where available, rather than treating uneven intervals as equal years. The model’s dates, number of periods, and rate convention must agree; a monthly cash flow discounted at an annual rate without conversion will not be aligned.
Independent reader supportYour contribution helps us test, update, and keep practical guides available for everyone.Worked example and sensitivity analysis
OpenStax’s hypothetical teaching example uses a six-year forecast, an 8% discount rate, 3% growth, and terminal cash flow set at 2.5 times the discounted sixth-year cash flow. It reports a total company value of about $13.55 million and an implied $13.55 per share in that example. Those figures illustrate a method under its stated assumptions; they are not market inputs or a recommendation. See OpenStax, Principles of Finance 2e, section 11.3.
A sensitivity table is more useful than treating one output as definitive. The grid below is a format for testing a model, not a set of prescribed values. Populate it by recalculating the same forecast at different WACC and terminal-growth assumptions:
| WACC terminal growth | Lower growth case | Base growth case | Higher growth case |
|---|---|---|---|
| Lower WACC case | Recalculate DCF | Recalculate DCF | Recalculate DCF |
| Base WACC case | Recalculate DCF | Base DCF output | Recalculate DCF |
| Higher WACC case | Recalculate DCF | Recalculate DCF | Recalculate DCF |
For every cell, use terminal growth below the applicable WACC and retain the same operating forecast unless the scenario explicitly changes it. For an exit-multiple model, vary the multiple instead of terminal growth. Also test material changes to cash-flow drivers such as revenue growth, margins, or reinvestment needs. Compare the resulting range with a market-multiples valuation, using genuinely comparable businesses and recognizing that market multiples bring their own assumptions.
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OpenStax cautions, “The discounted cash flow model is only as good as the information entered.” Its value can be undermined by inaccurate cash-flow estimates or an unrealistic required return; Corporate Finance Institute likewise identifies forecast cash flows, terminal value, and discount rate as sensitive assumptions (CFI’s DCF formula guide; CFI’s terminal value guide).
How to interpret a DCF result
Read a DCF output as a conditional estimate: given this cash-flow forecast, discount rate, and terminal-value assumption, the model produces this present value. It does not establish a uniquely correct intrinsic value. If small changes to plausible inputs produce a wide range, the uncertainty is a feature of the decision, not a spreadsheet error to conceal.
DCF is widely used by professional analysts, but market multiples are also common. CFA Institute’s 2026 curriculum, citing Pinto, Robinson, and Stowe’s 2019 study, reports that 78.8% of analysts use a discounted cash-flow approach and that 86.9% of analysts using DCF use a discounted free-cash-flow model. Those percentages refer to the study cited by the curriculum, not a 2026 survey.
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