Company valuation
How much is a company worth? The discounted cash flow method answers this through future cash flows and their present value.
Core idea
The discounted cash flow method assumes that company value equals the present value of all future free cash flows. A euro received in five years is worth less than a euro today because of time and risk, so each future cash flow is discounted back to the valuation date. The same logic applies to other assets, including rental property.
The formula
Three building blocks are required: a forecast of future free cash flows, a discount rate (the WACC) and a terminal value for the period after the explicit forecast, usually three to ten years.
Three building blocks
Putting it in context
The method is mathematically precise but only as good as its inputs. Small changes in WACC or long-term growth can move the result materially. A sensitivity analysis shows how dependent the value is on those assumptions. The worked example Discounted cash flow example takes the calculation from forecast to terminal value.
What actually counts
A DCF does not start with net income alone. Net income includes expenses that are not paid in the same year and does not show investment needs as clearly as cash flow does. Free cash flow asks what remains for capital providers after operations and necessary investment. In simplified form, start with after-tax operating profit, add back non-cash expenses such as depreciation, then subtract capital expenditure and the change in operating working capital.
Depending on the model, you may use free cash flow to the firm or free cash flow to equity. The key is to match the chosen cash flow with the discount rate. If profit grows while free cash flow stays negative, first understand where the cash is going. A growing company can invest heavily; that does not automatically make the valuation wrong, but the financing must be visible.
Process
Only then compare the result with the market price. A DCF should not prove that a share is cheap or expensive; it should make the expectations embedded in the price explicit.
Sensitivity
A single value looks decisive, but small changes in WACC, long-term growth or target margin can have large consequences. Terminal value is especially important because it often represents a large share of the result and lies far in the future.
A bear case might use slower growth, a lower margin and a higher WACC. A bull case is useful only if you can explain what would make it happen. If the current price leaves little room even in the bull case, that is a different signal from a price well below your base case.
Value and price
Enterprise value is not the same as the current share price. The market price comes from supply and demand; the DCF shows which cash flows, margins, growth rates and capital costs would be needed to justify it. A base case above the market price is interesting only if you can explain why the market has not already priced in those cash flows. Comparing the result with price is the beginning of the review, not the end.
A reverse DCF starts with the current price and makes the required future performance visible. See Reverse DCF: which expectations are already priced in?
Full Excel model with history, forecast, WACC calculator and sensitivity analysis.
Read next