Finance & Economics · Corporate Finance & Valuation · Valuation Models
DCF Valuation Calculator
Calculates the intrinsic value of an investment by discounting projected future cash flows back to their present value using a specified discount rate and terminal growth rate.
Calculator
Formula
V is the intrinsic (present) value of the investment. CF_t is the free cash flow in year t. r is the discount rate (typically WACC or required rate of return). n is the number of projection years. TV is the terminal value representing all cash flows beyond the explicit forecast period. CF_n is the cash flow in the final forecast year. g is the long-term perpetual growth rate of cash flows beyond year n.
Source: Brealey, Myers & Allen, Principles of Corporate Finance, 13th Edition; Gordon Growth Model for terminal value.
How it works
The core idea behind discounted cash flow analysis is the time value of money: a dollar received today is worth more than a dollar received in the future because today's dollar can be reinvested to earn a return. The DCF model therefore applies a discount rate — typically the Weighted Average Cost of Capital (WACC) for a firm, or a required rate of return for an individual investor — to reduce each future cash flow to its present value equivalent. The sum of all these discounted cash flows represents the total intrinsic value of the investment.
The formula has two components. First, the present value of explicit forecast cash flows (usually 5–10 years) is calculated by dividing each year's cash flow by (1 + r) raised to the power of the year number, where r is the discount rate. Second, a terminal value is computed to capture all cash flows beyond the explicit forecast horizon, using the Gordon Growth Model: TV = CF_n × (1 + g) / (r − g), where g is the stable long-term growth rate. This terminal value is also discounted back to the present by dividing by (1 + r)^n. The total intrinsic value is the sum of both components.
Choosing the right inputs is critical. The discount rate reflects the riskiness of the cash flows — higher risk demands a higher rate, which lowers the present value. The terminal growth rate must be conservative (typically 2–4%) and must always be lower than the discount rate to avoid mathematical infinity. Overestimating either the cash flow growth or underestimating the discount rate are the two most common errors in DCF models, and both lead to inflated valuations. DCF is used extensively in M&A due diligence, IPO pricing, capital budgeting, and personal investment analysis.
Worked example
Suppose you are valuing a small technology company. The projected free cash flows are: Year 1: $500,000, Year 2: $550,000, Year 3: $600,000, Year 4: $660,000, Year 5: $726,000. The company's WACC is 10% and the assumed long-term terminal growth rate is 3%.
Step 1 — Discount each cash flow:
PV Year 1 = $500,000 / (1.10)^1 = $454,545
PV Year 2 = $550,000 / (1.10)^2 = $454,545
PV Year 3 = $600,000 / (1.10)^3 = $450,789
PV Year 4 = $660,000 / (1.10)^4 = $450,789
PV Year 5 = $726,000 / (1.10)^5 = $450,789
Sum of explicit PVs = $2,261,457
Step 2 — Calculate Terminal Value:
TV = $726,000 × (1.03) / (0.10 − 0.03) = $747,780 / 0.07 = $10,682,571
Step 3 — Discount Terminal Value to present:
PV of TV = $10,682,571 / (1.10)^5 = $6,632,107
Step 4 — Total Intrinsic Value:
Intrinsic Value = $2,261,457 + $6,632,107 = $8,893,564
If the company's current market price implies a valuation below $8.89 million, the DCF analysis suggests it may be undervalued; above that level, it may be overvalued.
Limitations & notes
The DCF model is highly sensitive to its input assumptions — particularly the discount rate and terminal growth rate. Small changes in either can produce dramatically different intrinsic values, a phenomenon sometimes called the "garbage in, garbage out" problem. For example, reducing the discount rate from 10% to 9% or raising the terminal growth rate from 3% to 4% in the example above would increase the valuation by 15–25%. The model also requires reliable multi-year cash flow forecasts, which are inherently uncertain for early-stage companies, cyclical businesses, or firms undergoing structural change. The terminal value typically accounts for 60–80% of the total DCF value, making its assumptions disproportionately influential. This calculator uses a simplified 5-year explicit forecast period; in professional practice, 7–10 year models are common. DCF is not appropriate for financial institutions (banks, insurers) where free cash flow is difficult to define, nor for companies with negative cash flows and no near-term path to profitability without significant adjustments. Always use DCF alongside relative valuation methods (P/E, EV/EBITDA) for a more complete picture.
Frequently asked questions
What discount rate should I use in a DCF valuation?
For a company, the standard discount rate is the Weighted Average Cost of Capital (WACC), which blends the cost of equity (often estimated using CAPM) and the after-tax cost of debt, weighted by their proportion in the capital structure. For individual investors evaluating a stock, the discount rate may reflect a personal required rate of return — commonly 8–12% for equities. Using a rate that is too low overstates value; too high understates it.
What is a reasonable terminal growth rate for a DCF model?
The terminal growth rate should approximate the long-run nominal GDP growth rate of the economy in which the company operates — typically 2–3% for developed economies. It must always be strictly less than the discount rate; if it equals or exceeds the discount rate, the formula produces an infinite or negative terminal value. Using a rate above 4–5% for a mature company is generally considered aggressive and unrealistic.
Why does the terminal value make up such a large share of DCF value?
The terminal value captures all cash flows from Year n onward, which for a going concern is a perpetuity. In most DCF models, the terminal value accounts for 60–80% of total intrinsic value when a 5-year forecast horizon is used. This is mathematically expected: the present value of a perpetuity growing at 3% discounted at 10% (a 7% net rate) equals approximately 14x the final year's cash flow, which dominates any 5-year sum. This is why terminal growth rate assumptions are the most critical — and most scrutinised — inputs in any DCF.
How is DCF valuation different from relative valuation (comparables)?
DCF valuation is an absolute valuation method that derives intrinsic value purely from the company's own projected cash flows and risk profile, independent of market pricing. Relative valuation (comps) uses market multiples like P/E or EV/EBITDA from comparable companies to price the target. DCF is theoretically more rigorous but requires explicit forecasts; comps are faster and reflect current market sentiment. Professional analysts typically use both methods and triangulate between them.
Can DCF be used to value real estate or project investments?
Yes. DCF is widely used in real estate to value income-producing properties by discounting projected net operating income (NOI) or rental cash flows plus a projected sale price (analogous to terminal value). In capital budgeting, DCF is used to calculate Net Present Value (NPV) of projects — when NPV > 0, the project creates value. The same mathematical framework applies; only the definition of 'cash flow' changes depending on the asset type.
Last updated: 2025-01-15 · Formula verified against primary sources.