Discounted Cash Flow (DCF): Calculating Intrinsic Value
A DCF looks like the most rigorous thing in finance — a spreadsheet producing a precise per-share value. Most of that precision comes from two assumptions typed into cells near the bottom, and moving either by a percentage point can change the answer by half.
The one idea underneath it
A business is worth the cash it will hand its owners, and a dollar arriving in ten years is worth less than a dollar today — because today's dollar can be invested in the meantime, and because the future one might not arrive.
So a DCF does two things. It forecasts free cash flow: the cash left after the business has paid to sustain and grow itself, usually operating cash flow minus capital expenditure. Then it discounts each future year back to a present value at a rate reflecting the risk.
The discount rate is commonly the weighted average cost of capital — a blend of what the company pays for debt and what equity holders require. Its effect is powerful and worth feeling directly: raise it and every future dollar shrinks, so the valuation falls, with the most distant cash flows shrinking most.
Forecast the cash. Discount it for time and risk. Add it up. Everything else is detail about those three steps.
Where the value actually comes from
Nobody forecasts a company year by year forever, so a DCF projects explicitly for five or ten years and then bundles everything after that into a single terminal value — usually by assuming cash flows grow at a modest constant rate in perpetuity.
Terminal value typically accounts for the majority of the total, commonly 60–80%. That is the single most important fact about the method, and it inverts how most people use it: the five years of carefully researched forecasts drive a minority of the answer, while the assumed perpetual growth rate drives more.
The formula behind it divides by the gap between the discount rate and the perpetual growth rate. When those two numbers are close, that denominator is small and the terminal value explodes — so nudging perpetual growth from 2% to 3% against a 9% discount rate raises terminal value by roughly 17%, from one keystroke.
How to use one without fooling yourself
Because the output is so sensitive, a single DCF number carries false authority. The defensible practice is to run a range — vary the discount rate and terminal growth across plausible values and see how wide the resulting valuations are.
If a stock looks cheap under every reasonable combination, you've learned something. If it flips from undervalued to overvalued on a half-point change in an assumption nobody can pin down, you've learned that too, and the honest conclusion is that the method can't settle this one.
The real value of building a DCF is often not the number at the end. It's that the model forces you to state what you believe about growth, margins and reinvestment — and those assumptions, written down where they can be checked against what actually happens, are more useful than the valuation.
A DCF projects future free cash flow and discounts it to today. Terminal value typically dominates the output, so the valuation rests mostly on an assumed perpetual growth rate and discount rate — which makes a DCF a range to argue with, not an answer.
Sources
- Valuation teaching materials and datasets — Aswath Damodaran (NYU Stern) (2026)