Discounted Cash Flow (DCF): Definition, Formula, and How to Calculate It
Discounted Cash Flow (DCF) is a valuation method that estimates the intrinsic value of a company based on the present value of its expected future free cash flows. The idea is that a company is worth the sum of all future cash flows, discounted back to today to account for risk and the time value of money.
Implementation (exact formula used )
- Project annual FCFs for N years (N = 5 by default):The code reduces growth each year by a decay factor (0.97^(t-1)) and applies a floor for optimistic growth.
- Discount each projected FCF to present value:
- Compute terminal value using Gordon Growth (using the last projected FCF):
- Discount terminal value to present value:
- Enterprise value and per-share fair value:
Notes
- Small changes in discount rate or growth can drastically shift the valuation
- DCF is best used for stable businesses with forecastable cash flows
Why This Matters:
DCF attempts to capture the present value of future cash the company can return to shareholders. It is sensitive to growth and discount rate assumptions — small changes can materially alter the output.