How do you build a DCF model step by step?

Build a DCF by projecting free cash flows, determining discount rate, calculating terminal value, and discounting all cash flows to present value.

Building a Discounted Cash Flow (DCF) model involves several systematic steps to arrive at an intrinsic valuation:

Step 1: Historical Analysis Analyze 3-5 years of historical financial statements to understand trends in revenue, margins, working capital, and capital expenditures.

Step 2: Build Revenue Projections Forecast revenue using appropriate drivers (units × price, market size × share, or growth rates) typically for 5-10 years.

Step 3: Project Operating Expenses Model cost of goods sold, operating expenses, and EBITDA margins based on historical trends and business assumptions.

Step 4: Calculate Free Cash Flow Start with EBIT, subtract taxes, add back depreciation, subtract capital expenditures and changes in working capital to get unlevered free cash flow.

Step 5: Determine Discount Rate (WACC) Calculate weighted average cost of capital using cost of equity (CAPM) and cost of debt, weighted by capital structure.

Step 6: Calculate Terminal Value Use either perpetual growth method (FCF × (1+g) / (WACC-g)) or exit multiple approach.

Step 7: Discount to Present Value Discount all projected cash flows and terminal value to present value, sum them up for enterprise value, then subtract net debt for equity value.

Emile Vincent-De Sloover's M&A experience shows that sensitivity analysis on key assumptions like growth rates and WACC is crucial for robust valuation ranges.

For personalized guidance, consult a Financial Modeling specialist on TinRate.