Team AcumenSphere
|Last Updated: August 18, 2026
|Publish Date: August 18, 2026
A complete discounted cash flow calculation, carried from five-year projections through a WACC build-up and terminal value to a value per share — including the sensitivity range most published examples leave out.
Discounted cash flow is a valuation method that estimates what a business is worth today based on the cash it is expected to generate in the future. Because money available now is worth more than the same amount received later, each future cash flow is reduced — discounted — to reflect both the passage of time and the risk that the cash never arrives.
It is the most widely used income-approach method in professional valuation, and the one most often challenged in audit and diligence. This guide covers the formula, the model, and a complete calculation carried through to value per share.
The Discounted Cash Flow Formula
The DCF formula sums the present value of every cash flow the business is expected to produce:
PV = CF₁ / (1+r)¹ + CF₂ / (1+r)² + … + CFₙ / (1+r)ⁿ + TV / (1+r)ⁿ
Variable | Meaning | Typical source |
|---|---|---|
CF | Free cash flow in each forecast year | Management projections, adjusted |
r | Discount rate | WACC build-up or cost of equity |
n | Number of periods in the explicit forecast | Usually five years |
TV | Terminal value beyond the forecast period | Gordon Growth or exit multiple |
The mechanics are arithmetic. The judgment sits entirely in the inputs, which is why two analysts can apply an identical DCF calculation formula to the same business and arrive at values that differ by half.
When DCF Is the Right Method
Use DCF when | Avoid DCF when |
|---|---|
The business has a forecastable operating history | The company is pre-revenue with no forecast basis |
Cash flows are reasonably predictable | Earnings are volatile or cyclical without a normalized base |
The valuation must be defensible on fundamentals | A recent arm's length financing provides better evidence |
No close comparable companies exist | Reliable trading or transaction comparables are available |
In practice, valuation using DCF is rarely the only method applied. It is usually weighted alongside a market approach so that the two can be cross-checked against each other.
Which Cash Flow to Discount
The DCF method of valuation works with two different cash flow definitions, and pairing either with the wrong discount rate invalidates the result.
Free cash flow to the firm (FCFF) is the cash available to all capital providers, before debt service. It is discounted at the weighted average cost of capital and produces enterprise value.
Free cash flow to equity (FCFE) is the cash remaining after interest and debt repayments. It is discounted at the cost of equity and produces equity value directly.
The worked example below uses FCFF and WACC, which is the standard approach for company valuation. For the full derivation of both measures, see our guide to FCFF and FCFE.
A Complete DCF Calculation
The following example runs the full model for a business generating $20 million in revenue.
Step 1: Project Free Cash Flow
Year | 1 | 2 | 3 | 4 | 5 |
|---|---|---|---|---|---|
Free cash flow ($M) | 3.0 | 3.9 | 4.8 | 5.6 | 6.3 |
Growth | — | 30% | 23% | 17% | 13% |
Note the decelerating growth. A forecast that compounds at a constant high rate for five years is the most common signal of an unreliable model, because no business sustains its early growth rate indefinitely.
Step 2: Build the Discount Rate
The WACC is constructed from its components rather than assumed:
Component | Calculation | Result |
|---|---|---|
Risk-free rate | 20-year government bond | 4.5% |
Equity risk premium | Market premium | 5.5% |
Beta | Levered, from comparables | 1.2 |
Size premium | Small company adjustment | 2.4% |
Cost of equity | 4.5% + (1.2 × 5.5%) + 2.4% | 13.5% |
Cost of debt | Pre-tax borrowing rate | 8.0% |
After-tax cost of debt | 8.0% × (1 − 25%) | 6.0% |
Capital structure | 80% equity / 20% debt | — |
WACC | (0.80 × 13.5%) + (0.20 × 6.0%) | 12.0% |
Step 3: Discount the Cash Flows
Year | FCF ($M) | Discount factor at 12% | Present value ($M) |
|---|---|---|---|
1 | 3.0 | 0.8929 | 2.68 |
2 | 3.9 | 0.7972 | 3.11 |
3 | 4.8 | 0.7118 | 3.42 |
4 | 5.6 | 0.6355 | 3.56 |
5 | 6.3 | 0.5674 | 3.58 |
Total | 16.34 |
Step 4: Calculate Terminal Value
Terminal value captures every cash flow after year five. Using the Gordon Growth Model with a long-term growth rate of 2.5%:
TV = FCF₅ × (1 + g) / (WACC − g) = $6.3M × 1.025 / (0.12 − 0.025) = $67.97M
Discounted back five years: $67.97M × 0.5674 = $38.57M
The long-term growth rate must not exceed long-run economic growth. A terminal rate of 5% assumes the business eventually becomes larger than the economy containing it.
As a sanity check, the terminal value implies an exit multiple of 8.5x year-five EBITDA of $8.0 million. If comparable companies trade at 12x, the assumptions need revisiting.
Step 5: Bridge to Equity Value
Line | $M |
|---|---|
PV of explicit forecast cash flows | 16.34 |
PV of terminal value | 38.57 |
Enterprise value | 54.91 |
Less: debt | (8.00) |
Add: cash | 3.00 |
Equity value | 49.91 |
Fully diluted shares | 10,000,000 |
Value per share | $4.99 |
This final bridge is where many models stop short. Enterprise value is not what shareholders own, and a DCF value that has not been adjusted for debt and cash answers a different question than the one usually asked.
Terminal Value Dominates the Answer
In the example above, terminal value contributes $38.57 million of a $54.91 million enterprise value — 70.2% of the total.
That proportion is typical. Across most DCF models, terminal value represents 60% to 80% of the result. The implication is uncomfortable but important: the majority of the valuation rests on a single growth assumption applied beyond the forecast horizon, not on the detailed year-by-year projections that consume most of the modeling effort.
Any review of a discounted cash flow model should begin by calculating this percentage. If it exceeds 85%, the explicit forecast period is probably too short.
Sensitivity Analysis
A DCF produces a single number, which creates false precision. Testing the two most influential assumptions shows the actual range:
Enterprise value ($M) at varying WACC and terminal growth
g = 2.0% | g = 2.5% | g = 3.0% | |
|---|---|---|---|
WACC 11% | 59.2 | 61.9 | 64.9 |
WACC 12% | 52.8 | 54.9 | 57.2 |
WACC 13% | 47.6 | 49.3 | 51.1 |
Moving WACC by one percentage point in either direction, and growth by half a point, produces a range of $47.6 million to $64.9 million — a 36% spread around the base case.
A DCF valuation presented without a sensitivity table is presenting a point estimate as though it were a fact. Boards and auditors increasingly expect the range.
Where DCF Models Go Wrong
Hockey-stick forecasts. Projections that assume a step change in growth or margin with no operational explanation.
Terminal growth above GDP. Anything above roughly 3% for a mature economy requires justification.
Mismatched cash flow and discount rate. Discounting FCFF at the cost of equity, or FCFE at WACC.
Ignoring working capital. Growth consumes cash; a model that grows revenue without funding receivables and inventory overstates free cash flow.
Understated capital expenditure. Terminal-year capex below depreciation implies a shrinking asset base supporting perpetual growth.
Discounting mid-year versus year-end inconsistently. Cash arrives throughout the year, and the mid-year convention typically raises value by 5% to 6%.
Forgetting the dilution. Options and convertible instruments change the share count in the final bridge.
These are among the factors that drive business value in practice, and most of them are visible only when the model is examined rather than the output.
What Auditors and Investors Challenge
A discounted cash flow valuation submitted for audit or diligence is tested at the assumption level, not the arithmetic level. Reviewers typically ask:
Whether the forecast used in the DCF matches the forecast given to the board and to lenders
How the beta was derived, and whether the comparable set is defensible
What supports the size premium and any company-specific risk premium applied
Whether the terminal growth rate is consistent with long-run industry growth
What the implied exit multiple is, and how it compares with trading comparables
Whether historical forecast accuracy supports relying on management projections
The last point carries disproportionate weight. A company that has missed its own forecasts for three consecutive years will find that its projections are discounted in a second sense.
Get a Defensible DCF Valuation
A discounted cash flow model is only as credible as the assumptions supporting it, and those assumptions are what reviewers examine. AcumenSphere builds DCF valuations that document every input — forecast basis, discount rate derivation, terminal value support and sensitivity range — in a form that holds up through audit review and investor diligence.
If you need a valuation for financial reporting, a transaction, or a fundraise, contact our team to discuss your requirements.