DCF model example: the company and its assumptions
SensorCo is a fictional maker of industrial sensors, and every number in this discounted cash flow example is illustrative. Dollar figures are in millions. Last year SensorCo had revenue of $1,000 million and an operating (EBIT) margin of about 15%. The forecast assumptions:
- Revenue growth fades from 10% in year 1 to 9%, 8%, 6% and 5% by year 5, as growth usually slows when a company gets bigger.
- EBIT margin rises half a point a year, from 15.0% to 17.0%, as fixed costs are spread over more sales.
- Tax is 25% of EBIT.
- Reinvestment: capital spending of 6% of revenue against depreciation and amortization (D&A) of 4%, and working capital equal to 10% of revenue, so each extra $1 of sales ties up $0.10.
- Balance sheet: $400 million of debt, $150 million of cash, 95 million basic shares, 6 million options with a $20 strike, 2 million restricted stock units (RSUs) and a $24 share price.
Step 1: Forecast free cash flow from revenue, margin and reinvestment
Build free cash flow from its drivers rather than growing last year's figure at a flat rate. For a firm-level DCF, use unlevered free cash flow, which belongs to lenders and shareholders together:
Unlevered FCF = EBIT × (1 − tax rate) + D&A − capital spending − increase in working capital
EBIT after tax is NOPAT, net operating profit after tax. Figures are rounded, so rows may not sum exactly.
| Year | Revenue | EBIT | NOPAT | + D&A | − Capex | − Working capital | FCF |
|---|---|---|---|---|---|---|---|
| 1 | 1,100.0 | 165.0 | 123.8 | 44.0 | 66.0 | 10.0 | 91.8 |
| 2 | 1,199.0 | 185.8 | 139.4 | 48.0 | 71.9 | 9.9 | 105.5 |
| 3 | 1,294.9 | 207.2 | 155.4 | 51.8 | 77.7 | 9.6 | 119.9 |
| 4 | 1,372.6 | 226.5 | 169.9 | 54.9 | 82.4 | 7.8 | 134.6 |
| 5 | 1,441.2 | 245.0 | 183.8 | 57.6 | 86.5 | 6.9 | 148.1 |
Free cash flow rises from 8.3% of revenue in year 1 to 10.3% in year 5, because margins widen and slower growth needs less new working capital. Growth is not free: in year 1 SensorCo reinvests about a quarter of its NOPAT to grow 10%. A forecast that raises growth without raising reinvestment is quietly assuming a better business.
Step 2: WACC in plain terms, then discount
WACC is the return SensorCo's shareholders and lenders, taken together, require for the risk they carry. It converts future dollars into today's dollars. Its three inputs are judgement calls (illustrative):
- Cost of equity from the capital asset pricing model: a 4% risk-free rate plus a beta of 1.1 times a 5% equity risk premium = 9.5%.
- After-tax cost of debt: 6% interest × (1 − 25%) = 4.5%, because interest is tax-deductible.
- Weights: a long-run mix of 80% equity and 20% debt.
WACC = 0.80 × 9.5% + 0.20 × 4.5% = 8.5%. Discounting each year's free cash flow:
| Year | FCF ($m) | Divide by (1.085)ᵗ | Present value ($m) |
|---|---|---|---|
| 1 | 91.8 | 1.085 | 84.6 |
| 2 | 105.5 | 1.177 | 89.6 |
| 3 | 119.9 | 1.277 | 93.9 |
| 4 | 134.6 | 1.386 | 97.2 |
| 5 | 148.1 | 1.504 | 98.5 |
| Total | 463.7 |
Step 3: Terminal value, perpetuity growth versus exit multiple
The forecast stops at year 5 but the business does not. The terminal value captures everything after, and there are two standard ways to estimate it.
Perpetuity (Gordon growth) method. Assume free cash flow grows 2.5% a year forever. Year-6 FCF = 148.1 × 1.025 = $151.8 million, and terminal value = 151.8 ÷ (0.085 − 0.025) = $2,530 million at the end of year 5.
Exit multiple method. Assume the business could be valued at the end of year 5 at 10 times its EBITDA (EBIT plus D&A) of $302.7 million: $3,027 million.
| Method | Terminal value ($m) | Present value ($m) | Enterprise value ($m) | Terminal share of EV | Implies |
|---|---|---|---|---|---|
| Perpetuity, 2.5% growth | 2,530 | 1,682 | 2,146 | 78% | 8.4× year-5 EBITDA |
| Exit, 10× EBITDA | 3,027 | 2,013 | 2,477 | 81% | 3.4% growth forever |
Use each method to check the other. The perpetuity value implies SensorCo is worth 8.4 times EBITDA in year 5; if similar companies trade well away from that, find out why. The 10× exit multiple implies free cash flow growing 3.4% a year forever at an 8.5% WACC, more than the 2.5% assumed. An exit multiple borrows today's market pricing and applies it five years out, while the perpetuity method makes you state the growth rate outright, so a common approach is to use the perpetuity figure as the base case and the multiple as a cross-check.
Step 4: From enterprise value to value per share
Enterprise value belongs to every capital provider. To reach shareholders, subtract other claims, then divide by every share that will share the remainder:
- Enterprise value (perpetuity case): 463.7 + 1,682.3 = $2,146 million.
- Less net debt: $400 million of debt − $150 million of cash = $250 million. Where they exist, also subtract preferred stock, minority interests and unfunded pension obligations.
- Equity value = $1,896 million.
- Diluted shares by the treasury stock method: the 6 million options are in the money at $24, and the $120 million paid to exercise them buys back 5 million shares, a net 1.0 million new shares. Add the 2 million RSUs: 95 + 1 + 2 = 98 million.
- Value per share = 1,896 ÷ 98 = $19.35. The exit-multiple case gives $22.72.
Dividing by the 95 million basic shares would give $19.96, overstating value by about 3%. For companies that pay heavily in stock, the gap is larger.
Step 5: Build a sensitivity table
WACC and terminal growth move the answer most, so recompute the value per share across a grid of both:
| WACC | Terminal growth 2.0% | Terminal growth 2.5% | Terminal growth 3.0% |
|---|---|---|---|
| 7.5% | $21.84 | $23.89 | $26.41 |
| 8.5% | $17.95 | $19.35 | $21.00 |
| 9.5% | $15.10 | $16.10 | $17.26 |
A one-point change in WACC moves the value by roughly $3 to $5 a share, and the grid spans about $15 to $26. The $24 share price is reached only in the low-WACC corner, or with an exit multiple of about 11 times EBITDA ($24.77). Rather than tuning inputs until the model agrees with the market, ask what growth the price implies, which is the subject of implied growth rate.
Step 6: Sanity checks before you trust the number
- How much rests on the terminal value? 78% here, which is common in a five-year model but means the forecast years decide little. A longer forecast with a gradual fade spreads the weight.
- Is the implied multiple sensible? The perpetuity value equals 17.1 times year-5 free cash flow and 8.4 times EBITDA. Compare both with what similar businesses trade at.
- Does reinvestment match growth? Growth = reinvestment rate × return on new capital. SensorCo reinvests 19.4% of NOPAT in year 5; carried into the terminal period at 2.5% growth, that implies about a 13% return on new capital, above the 8.5% WACC. If new investment earns only 10%, the value-driver formula, TV = NOPAT × (1 − g ÷ return on new capital) ÷ (WACC − g), gives $18.16 a share. What is ROIC covers the return side.
- Are the margins plausible? The model lifts EBIT margin from 15% to 17%. Check the company's own history and its best peers before assuming expansion.
- Is stock-based pay counted? If it is material, subtract it from free cash flow or grow the share count.
Then turn the grid into bear, base and bull cases, as the stock valuation guide describes. That is how to build a DCF model you can defend. VALYSTR's Stock Analyzer loads a real company's financials and lets you set and stress-test the same assumptions.
Build a DCF on a real company
Load a company's financials into the Stock Analyzer, set bear, base and bull assumptions, and stress-test the inputs that move value most.
Frequently asked questions
How do you build a DCF model step by step?
Forecast revenue, operating margin and reinvestment for five to ten years to get unlevered free cash flow. Discount each year at the weighted average cost of capital, add the discounted terminal value, subtract net debt and other claims, and divide by diluted shares. Finish with a sensitivity table and sanity checks on the terminal value, margins and reinvestment.
What terminal growth rate should I use in a DCF?
Use a rate the business could sustain forever, which means no faster than the long-run growth of the economy it sells into. Many analysts use 2% to 3%. The rate must sit below the discount rate, and the closer the two are, the more the terminal value dominates, so test a range rather than relying on one figure.
Is the perpetuity method or the exit multiple method better?
Neither is always better, so use both. The perpetuity method makes you state long-run growth explicitly but is sensitive to it. The exit multiple reflects what the market pays today but assumes that multiple still applies years from now. Convert each into the other's terms, an implied multiple or an implied growth rate, and question any large gap.
Why is the terminal value so large in a DCF?
A five-year forecast covers only a small part of a business's life, and everything after year five is compressed into the terminal value. It often accounts for well over half of enterprise value, and 78% in this example. A longer forecast period with growth fading gradually spreads the weight, and a sensitivity table shows how much the answer depends on those long-run inputs.
How do you get from enterprise value to share price in a DCF?
Subtract net debt, meaning debt minus cash, from enterprise value, along with preferred stock, minority interests and unfunded pensions. That leaves equity value. Divide it by diluted shares, counting in-the-money options with the treasury stock method plus restricted stock units, to get value per share, then compare that estimate with the market price.