A Discounted Cash Flow, Step by Step
Build a simple DCF from scratch and watch how each assumption swings the answer.
Let’s build a deliberately simple DCF so the mechanics are concrete. Say a company generates ₹100 cr of free cash flowCash left after running and reinvesting in the business. this year, you expect it to grow 10%/year for 5 years, and you use a 12% discount rate.
- Project FCFCash left after running and reinvesting in the business.: Yr1 ₹110, Yr2 ₹121, Yr3 ₹133, Yr4 ₹146, Yr5 ₹161 cr (growing 10%).
- Discount each back at 12%: roughly ₹98, ₹96, ₹95, ₹93, ₹91 cr.
- Add a terminal value for everything after year 5, then discount that too.
- Sum all present values → your intrinsic-value estimate. Compare it to the market capA company’s total market value: share price × number of shares..
Here’s the eye-opener: nudge the growth rate from 10% to 14%, or the discount rate from 12% to 10%, and the answer can swing 30–50%. A DCF is brutally sensitive to its assumptions — which is its great lesson, not its flaw: it shows that “precise” valuationsEstimating what an asset is worth. are an illusion and you must think in ranges.
Common mistakeTreating a DCF’s output as a precise truth. Garbage-in, garbage-out: tiny changes in inputs produce wildly different “fair values.” Use it to understand the drivers and bound a range, never to claim a stock is worth exactly ₹1,847.
Key takeawayA DCF projects and discounts futureA binding agreement to buy or sell at a set price on a future date. cash to an intrinsic valueWhat an asset is really worth, based on its fundamentals. — but it’s hyper-sensitive to growth and discount-rate assumptions, so treat its output as a range, not a fact.
FAQs
Is DCF worth doing if it’s so sensitive?
Yes — its value is in forcing you to think clearly about growth, cash generation and risk, and in revealing what the current price implies. Run optimistic/base/pessimistic cases to get a range rather than a single false-precision number, and use our valuation calculators to test scenarios.