valuation
Discounted cash flow (DCF) values an asset as the present value of expected future cash flows, discounted at a rate that matches the risk of those cash flows. In firm valuation the usual cash flow is FCFF and the usual rate is WACC.
A discounted cash flow is the income approach in arithmetic form. You forecast cash that the asset can distribute after reinvestment, then shrink those amounts by a discount rate that reflects their risk and the time they arrive. IVS, CFA equity-valuation readings, and Damodaran's firm-valuation chapters all rest on that sentence.
The standard unlevered (firm) model is:
EV = Σ_{t=1..n} FCFF_t / (1 + WACC)^t + TV_n / (1 + WACC)^n
FCFF_t = EBIT_t × (1 − t) + D&A_t − capex_t − ΔNWC_t (± other operating items)
WACC must match FCFF: after-tax cost of capital for operations. An equity DCF uses FCFE and the cost of equity instead. Mixing FCFF with cost of equity double-counts or ignores leverage.
Terminal value is usually most of the EV. That is not a scandal if fade, g, and exit multiple are coherent; it is a scandal if year-n is a fantasy.
Growth in the explicit period must be financed: higher growth needs capex and NWC. The tax rate should match the cash-tax story, not a statutory headline if the firm has NOLs. WACC weights should be target structure if you assume the firm will migrate, and the beta should match the operations (unlever/relever). Mid-year convention is a small honesty for intra-year cash arrival.
IAS 36 "value in use" is a cousin DCF with entity-specific cash flows and a pre- or post-tax rate applied consistently; it is not automatically market-participant intrinsic value.
Harbourline Components, invented, illustration only. WACC 9.5%; g 2.0%; explicit 8 years.
| Year | FCFF (€m) | PV at 9.5% |
|---|---|---|
| 1 | 4.1 | 3.7 |
| 2 | 4.4 | 3.7 |
| 3 | 4.6 | 3.5 |
| 4–8 (sum of PVs) | 14.1 | |
| Sum of explicit PVs | 25.0 | |
| TV (Gordon on year-8 FCFF 5.5 growing at 2%) | 5.5 × 1.02 / (0.095 − 0.02) = 74.8 | PV 35.9 |
| EV | 60.9 |
Net debt €9.2m → equity €51.7m in this illustration. An exit-multiple TV at 8.0x year-8 EBITDA should be shown as a cross-check, not a silent swap that inflates g.
Buyers use DCF to test whether a bid is payable without heroic fade. Sellers use it to show stand-alone worth when comps are scarce. LBO models are DCFs with a debt schedule; the professional question is whether operating FCFF can service the plan. Sensitivity on WACC and g is not appendix theatre: it is the risk disclosure.
Garbage-in, precise-out. DCF struggles with binary regulation and with firms that will not be going concerns. It can be gamed more easily than a tight peer set. That is why triangulation with comps and precedents is professional, not indecisive.
Dazur's DCF is a conversation tool: a base, a downside where growth and margin are earned more slowly, and a WACC/g grid. We will not "win" a process with a 12-decimal NPV. We will stop an inflated ask—or an insultingly low bid—when the cash simply cannot get there.