Walk Me Through a DCF

1. Project free cash flow for 5-10 years. For unlevered DCF (the standard), start with EBIT, tax it, add back D&A, subtract CapEx and the change in net working capital to get unlevered FCF. 2) Calculate the discount rate (WACC) — the blended cost of debt and equity, weighted by capital structure. 3) Discount the projected FCF back to present value using WACC. 4) Calculate terminal value using either the Gordon Growth (perpetuity growth) method or the exit multiple method, then discount it back too. 5) Sum the PV of FCF plus the PV of terminal value to get enterprise value, then subtract net debt (and other claims like preferred and minority interest) to get equity value, and divide by diluted shares for implied share price.

The standard interview answer uses UNLEVERED free cash flow (free cash flow to the firm), which is cash flow before the effects of debt. Because it ignores interest, it represents cash available to ALL capital providers, so you discount it at WACC and arrive at enterprise value. If you instead projected LEVERED FCF (after interest), you would discount at cost of equity and arrive directly at equity value. Interviewers expect unlevered unless they ask otherwise — mixing the two (e.g., levered FCF discounted at WACC) is an instant red flag.

Terminal value usually makes up 60-80% of the total DCF value, so interviewers probe it. Two methods: Gordon Growth = final-year FCF x (1 + g) / (WACC - g), where g is a perpetual growth rate (typically 2-3%, never above long-run GDP). Exit multiple = final-year EBITDA x a chosen EV/EBITDA multiple from comps. Best practice is to compute both and sanity-check them against each other — if Gordon Growth implies a 30x exit multiple, your assumptions are off. Remember terminal value is computed as of the final projection year, so it must still be discounted back to today.

After the walkthrough, expect: 'Which has the bigger impact on value, the discount rate or the growth rate?' (discount rate, because it compounds across every year). 'What's wrong with a DCF?' (highly sensitive to assumptions, especially terminal value and WACC). 'How would you mid-year convention change it?' (discount periods of 0.5, 1.5, etc., raising value slightly). 'If WACC goes up, what happens to value?' (it falls). Knowing these makes the difference between a 'fine' and a 'strong' technical rating.