Question 1

What is Discounted Cash Flow (DCF) Valuation?

Accepted Answer

Discounted Cash Flow (DCF) is a valuation method that estimates the intrinsic value of an investment or company based on the present value of its expected future Free Cash Flows (FCF).

Question 2

How is Free Cash Flow to Firm (FCFF) calculated?

Accepted Answer

FCFF is calculated as: Operating Cash Flow (or EBIT × (1 - Tax Rate) + Depreciation & Amortization) minus Capital Expenditures (CapEx) minus Changes in Working Capital.

Question 3

What is WACC (Weighted Average Cost of Capital)?

Accepted Answer

WACC represents a company's blended cost of capital across equity and debt, serving as the required discount rate to discount future cash flows back to present value.

Question 4

How is Terminal Value calculated in a DCF model?

Accepted Answer

Terminal Value uses the Gordon Growth Model: Terminal Value = [ Final Year FCF × (1 + g) ] / (WACC - g), where g is the perpetual terminal growth rate (typically 2% to 4% matching long-term GDP).

Question 5

How do you derive Fair Value Per Share from Enterprise Value?

Accepted Answer

Equity Value is derived as: Enterprise Value - Net Debt (Total Debt - Cash & Cash Equivalents). Fair Value per share = Equity Value / Diluted Shares Outstanding.

Question 6

What is Margin of Safety in DCF valuation?

Accepted Answer

Margin of Safety is the discount (e.g. 20% to 30%) an investor demands below the DCF calculated intrinsic value before buying the stock, protecting against estimation errors.

Question 7

Why can Terminal Value make up 60%–80% of total DCF value?

Accepted Answer

Because a company is assumed to operate indefinitely (going concern), the perpetual cash flows beyond the 5–10 year forecast period compound into the majority of present enterprise value.

Question 8

What are the key limitations of DCF valuation?

Accepted Answer

DCF models are highly sensitive to small changes in inputs (such as WACC discount rate and terminal growth rate assumptions), which can dramatically swing the fair value per share.

Question 9

When is DCF valuation not suitable?

Accepted Answer

DCF is unsuitable for early-stage startups with negative cash flows, highly cyclical commodity firms with unpredictable earnings, and financial companies/banks (where cash flows cannot be separated from financing operations).

Question 10

What is the difference between DCF and Reverse DCF?

Accepted Answer

Standard DCF estimates cash flow growth to calculate intrinsic stock price. Reverse DCF takes the current market stock price and solves for the implied growth rate priced in by the market.

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