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 in code)
- 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.