DCF Model – Calculating Discounted Cash Flows

DCF Model

DCF Model – Calculating Discounted Cash Flows

A Discounted Cash Flow (DCF) model is a popular financial model used to estimate the value of a company in order to assess the attractiveness of an investment opportunity. DCF analysis uses future free cash flow projections and discounts them to arrive at their present values, which is used to evaluate the potential for investment by comparing the asking price vs. the valuation result. The proposed investment is considered attractive if the value arrived through DCF model is higher than the current cost of the investment. If there are several opportunities, the investment proposal with the highest difference between value arrived with DCF and the current cost of investment shall be selected. Such difference can also be called Present Value.

Example DCF Valuation Model


Get the DCF Valuation Model Template here

This simple DCF model in Excel allows you to value a company via the Discounted Free Cash Flow (DCF) valuation method. The discounted cash flow valuation model uses a three statement model to derive free…

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Step 1 – Calculation of Historical Cash flows

You might be wondering why we should calculate historical cash flows if DCF analysis is all about discounting future free cash flows? – It is relevant because DCF analysis is based on the two major components: Discount Rate and Growth Rate. Existing data is required to at least validate our assumptions going forward. Also, one should never do a DCF analysis without first analyzing the company’s historical financials in order to obtain a better understanding of the company and the industry it operates in.

Free cash flows are the cash available for distribution to investors and lenders. There are two types of free cash flows:

  • Unlevered Free Cash Flows (UFCF): It is the cash flow available to investors and lenders without taking into account the financing structure (debt/equity) of the business. The magic formula is:

UFCF = EBIT(1-T) – CapEx + Depreciation & Amortization – Change in Net Working Capital

  • Levered Free Cash Flows (LFCF): It is the cash flow available only to investors in the equity portion of the capital structure, meaning, available only to shareholders.

 LFCF = UFCF  – Interest Exp + Change in Financial Debt

Kindly note,

  • EBIT (Earnings before Interest and Taxes) should be normalized first as historic profits might be affected by extraordinary items.
  • t stands for the effective historic tax rate which often can be very different between historic and future cash flows
  • CapEx stands for capital expenditures, which means investments in tangible and intangible assets as those are cash relevant but will not show up in the company’s profits (measured by EBIT)

In both the formulas, we have taken EBIT (1-t) and not net income. Operating profit best represents company operations and hence, EBIT is used. Taxes and capital expenditures are deducted as they are both cash operating expenses. Depreciation and Amortization are added because they are non-cash expenditure. Whereas an increase in net working capital is subtracted as cash needs to be invested in inventory, receivables etc.

With levered cash flow, subtract interest expense + change in debt financing (which together equals the debt service) as the distribution is to be made only to the equity investors and hence, the effect from debt service has to be excluded.

Investment banks and investors generally use Unlevered Free Cash Flows as the financing structure should not affect the firm value in theory and financing structures will change quite often. Only when valuing highly levered companies or assets such as insurance firms, banks or real estate properties, the levered free cash flow makes more sense to use since the whole rationale in those industries is about benefiting from leverage.


Step 2 – Projection of Future cash flows

As next step, we need to develop projections of our free cash flow forecast into the future.  For this, we need to determine projections normally for a minimum period of 5 years, in some cases (e.g. projects with an end date) even 10, 20, 30 or 50 years. The process for projection requires the following yearly estimations:

  • Forecasting income statement (for EBIT) for the next five years using the growth rate
  • Projecting change in working capital and capital expenditures
  • Depreciation and amortization are a function of already existing assets and should also account for additional assets

A typical projection of unlevered free cash flows looks like this:

Unlevered Free Cash Flows

The important thing here is to project revenues bottom up by applying the segment reporting basis and using different growth rate for each segment.

For EBIT, income statements shall be made and growth shall be used accordingly on sales. For other components of the free cash flows, balance sheets, and cash flow statements, are also projected. A simple but less useful method is to calculate such components as % of sales and applying growth rate accordingly. At the end of the forecast period, we need to estimate a perpetuity growth factor to calculate the terminal value of the cash flows.


Step 3 – Calculating Discount Rate

The discount rate reflects the opportunity cost of capital, which is normally measured by the Weighted Average Cost of Capital (WACC). WACC is an important concept as when using IRR analysis, the WACC will be the hurdle rate, the required return on investment should achieve, otherwise, the risk is higher than its benefits. In that case, cash flows are made equal to their present value and the net present value will be zero.

The popular ways to calculate Discount rate are :

  • Weighted Average Cost of Capital (WACC): Applicable to discount the unlevered free cash flows (UFCF) Using a simple weighted average cost of capital (For UCFC):

WACC = (E/V )*CoE + (D/V)*CoD*(1-Tc)

Here we are multiplying the weight of equity in the capital structure (E/V) by the Cost of Equity(CoE) . The weight of debt in the capital structure (D/V) multiplied by the Cost of Debt(CoD) times 1 minus the Effective Tax Rate (Tc) which is the debt portion of the discount rate.

  • Cost of Equity (CoE): Applicable to discount the levered free cash flows (LFCF) or as the Cost of Equity used for in WACC. Cost of Equity mostly is estimated by using the Capital Asset Pricing Model (CAPM):

R = Rf + β(Rm – Rf)


R is Required Return/Discount Rate

Rf equals to the risk-free rate of an investment

Β equals stock’s beta

Rm equals overall stock market risk


Step 4 – Calculating Terminal Value

It is the value of the firm for years beyond the last projected year as the idea of business is based on going concern basis. There are many ways to calculate the terminal value. To keep it simple, practitioners mostly use one of the two following methods to calculate the terminal value are

  1. Perpetual Growth Model: Here, the assumption is the last growth rate will apply forever.

Terminal Value = [Last Projected FCF * (1 + Perpetual Growth Rate)] / [Discount Rate – Perpetual Growth Rate]

FCF means free cash flows, which can be either levered or unlevered, depending on which concept is being used.

  1. Exit Multiple Method: Here, terminal value of cash flows is a multiplier of income flows measure such as EBITDA which can be observed from select trading multiples in the same industry or from recent benchmark transactions. EBITDA is a profit measure before taking into account debt/equity costs, thus, EBITDA only makes sense when compared to the Enterprise value (EV) and should only be used when using Unlevered Free Cash Flows.

Terminal Value = Exit EV/ EBITDA Multiple * Last Projected Year’s EBITDA


Step 5 – Discounting Cash Flows

In this last step, we should discount projected cash flows and terminal value to the present value. This is called Net Present Value (NPV) of future cash flows. The sum of the cash flows is equal to the value of the enterprise for unlevered free cash flows or equity value for the levered free cash flows.

Thus, when using unlevered free cash flows and calculating the NPV (= Enterprise Value), one needs to deduct debt and add cash as per the valuation date.

DCF Model

Kindly refer to the example DCF Valuation Model.


Get the DCF Valuation Model Template here

This simple DCF model in Excel allows you to value a company via the Discounted Free Cash Flow (DCF) valuation method. The discounted cash flow valuation model uses a three statement model to derive free…

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 A DCF model translates a business plan into a company valuation. The model captures all the key values drivers, which can be operational in nature but also model related, such as the WACC, growth rate. Having a DCF model ready is very useful to explain the economics of a business and discuss its impact on the valuation.

The DCF Method is one of the theoretically most sound valuation concepts since it bases on an income approach. It’s also superior to using a capitalized earnings valuation when capitalizing net income, which is an accounting measure but not a cash measure. Cash is more difficult to manipulate than accounting profits. For investors, cash is king, thus, the DCF method enjoys a high acceptance rate by many finance professionals.

Free cash flows are a reliable measure of a firm’s health that eliminates window dressing and subjective accounting policies. Hence, it can be said free cash flows are really the money available to the investors. So, DCF is more reliable financial valuation model.

DCF analysis is best used when the business is already in existence for a few years and forecast to some extent can be compared to historical performance. For Startups, a DCF model is more difficult to develop or even to read, since historical data is not available. As the entrepreneur, of course, will have a very optimistic view on his future, it’s more difficult to buy into this without real validation.

In practice, a DCF model is only as good as the quality and validation of the underlying financial projections (the business plan). As such any DCF model will be subjective and heavily dependent on the plausibility of its argumentation. Hence the value of the same firm may result in a higher or lower valuation depending on how optimistic or conservative the analyst’s projection are.


Example DCF Models

Here are some links to example DCF valuation models you can check out:

Allows user to enter various inputs about their business cash flows and get a straight forward valuation based on the Gordon Growth Model logic.

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Purchase Excluding 7.7% tax

The Poultry Farm Valuation Model allows forecasting the financial statements for a poultry farm based on operational metrics such as the hatchery ratio, mortality rate etc. The financial model calculates the resulting DCF value of…

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Purchase Excluding 7.7% tax

The Hotel Valuation Financial Model provides a simple way to forecast the expected cash flows for a hotel investment and calculates the relevant investor metrics such as the IRR (levered and unlevered).

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Purchase Excluding 7.7% tax

This is a comprehensive financial forecasting model for a hospital in Excel. The model uses a bottom-up approach to estimate the future cash flows for a hospital over the next 10 years and is linked…

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Purchase Excluding 7.7% tax

The DCF Valuation Model for Restaurants provides a business plan in the form of an Excel Template to value a restaurant based on the Discounted Cash Flow Method.

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Purchase Excluding 7.7% tax

This simple DCF model in Excel allows you to value a company via the Discounted Free Cash Flow (DCF) valuation method. The discounted cash flow valuation model uses a three statement model to derive free…

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The Dairy Farm Valuation Model forecasts the expected financials for a dairy farm and calculates the resulting DCF value.

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Purchase Excluding 7.7% tax

The commercial real estate valuation model template can be used to quickly value a commercial property such as an office building, industrial site, logistics or storage or a retail building via DCF valuation.

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Purchase Excluding 7.7% tax

A nice deal builder for valuing and analyzing apartment building cash flow.

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Purchase Excluding 7.7% tax
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Generic DCF Valuation Model

DCF Valuation Model Restaurant

Gordon Growth DCF Valuation Model

Hotel Valuation Model

Apartment Complex Cash Flow and Valuation Model

Commercial Real Estate Valuation Model

Valuation Model Can Flood Manufacturing Company

Hospital Financial Model

Dairy Farm Valuation Model

Poultry Farm Valuation Model

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