Definition
DCF analysis is the foundation of intrinsic valuation. It projects a company's free cash flows over a forecast period (typically 5-10 years), then discounts them back to present value using the weighted average cost of capital (WACC). A terminal value captures value beyond the projection period. The result represents the theoretical intrinsic value of the business.
functions Formula
Intrinsic Value = Σ(FCFt / (1+WACC)^t) + Terminal Value / (1+WACC)^n
lightbulb Example
Projected 5-year FCF: $10M, $12M, $14M, $16M, $18M. WACC = 10%. Terminal value at 3% growth = $18M × 1.03 / (0.10-0.03) = $264.9M. PV of cash flows + PV of terminal ≈ $220M enterprise value.
Pro Tip
Always run sensitivity analysis on WACC (±1%) and terminal growth rate (±0.5%)—small changes can swing value 20-30%.
verified_user Key Points
- Gold standard of intrinsic valuation
- Highly sensitive to WACC and terminal value assumptions
- Terminal value often represents 60-80% of total value
- Model garbage in = garbage out—assumptions drive results