How a DCF turns a cash-flow forecast into a value
The idea behind a discounted cash flow is that a dollar arriving years from now is worth less than a dollar today, because today’s dollar can be invested in the meantime. A DCF makes that precise: it takes each year’s expected free cash flow, discounts it back to the present at a rate r that reflects the time value of money and the risk of those flows, and adds the results together. Because a business does not stop at the end of the forecast, a terminal value stands in for all the cash beyond the final forecast year — usually as a perpetuity that grows at a steady rate g. The intrinsic value is simply the sum of every discounted forecast cash flow plus the discounted terminal value.
The DCF formula
PV(year t) = FCFt / (1 + r)t
Terminal = FCFN · (1 + g) / ( r − g )
Value = Σ PV(FCFt) + Terminal / (1 + r)N
where FCFt = free cash flow in year t,r = discount rate, g = terminal growth rate, andN = the final forecast year. The terminal value is computed at year N and then discounted back like any other future amount. The perpetuity only makes sense when r exceeds the terminal growth g; if r ≤ g the formula is undefined. The discount rate is usually the WACC calculator’s weighted average cost of capital for a firm, or your required return otherwise.
What makes this calculator different
- A per-year present-value breakdown. Every forecast year’s free cash flow is discounted separately and shown, with a chart so you can see how the present values taper off the further out they sit.
- The terminal value’s share, made explicit. It reports how much of the total value comes from the discounted terminal value versus the explicit forecast — often a surprisingly large fraction.
- It flags the undefined case. When the discount rate is less than or equal to the terminal growth rate the perpetuity has no finite value, and the calculator tells you instead of returning a misleading number.
Frequently asked questions
What is a discounted cash flow (DCF) and how does it work?+
A discounted cash flow values an asset as the present value of all the cash it is expected to generate. You forecast the free cash flow for an explicit horizon — typically five to ten years — then add a terminal value that captures everything beyond the forecast in a single figure. Each of those amounts is discounted back to today at a rate that reflects the time value of money and the risk of the cash flows. Summing the discounted forecast cash flows and the discounted terminal value gives the asset’s intrinsic value, which you can compare against its market price.
What is free cash flow?+
Free cash flow is the cash a business produces after paying its operating costs and the capital investment needed to keep running and growing. In a firm-level model it is usually unlevered free cash flow — roughly operating profit after tax, plus non-cash charges like depreciation, minus capital expenditure and increases in working capital — because that is the cash available to all investors before financing. It is the right quantity to discount because it represents real, distributable cash rather than accounting earnings, which can be distorted by non-cash items and timing. This calculator takes your free-cash-flow forecast directly so you control the assumptions.
What is terminal value and how is it calculated?+
Terminal value represents all the cash flows that occur after the explicit forecast period, collapsed into one number at the end of the final forecast year. The most common method is the Gordon growth perpetuity, which assumes free cash flow grows at a constant rate g forever after the last forecast year. It is computed as the final year’s cash flow grown one period and divided by the discount rate minus that growth rate: FCF_N · (1 + g) / (r − g). That terminal figure sits at year N, so it must itself be discounted back to today like any other future amount. Because it covers an infinite tail, the terminal value often makes up the majority of a DCF’s total value.
What discount rate should I use?+
The discount rate should reflect the riskiness of the cash flows you are valuing. When you discount unlevered free cash flow for a whole firm, the standard choice is the weighted average cost of capital (WACC), which blends the cost of equity and the after-tax cost of debt in proportion to how the firm is financed. For an equity investor valuing cash flows to shareholders, or for a personal investment, the appropriate rate is your required rate of return — the minimum return you need given the risk and your alternatives. The higher the rate, the more heavily future cash flows are discounted, so the choice has a large effect on the result.
Why is a DCF so sensitive to its assumptions?+
A DCF compounds small input changes over many years, so modest shifts in the growth rate or the discount rate can swing the valuation dramatically. The terminal value is the biggest culprit: because it is a perpetuity, the gap between the discount rate r and the terminal growth rate g sits in the denominator, and as g approaches r that denominator shrinks and the value explodes. Much of a typical DCF’s total value lives in the terminal value, which means the result hinges on two of the hardest-to-estimate inputs. The practical takeaway is to treat any single DCF output as a point on a range, and to test how it moves when you vary the key assumptions.
Disclaimer: This calculator is foreducation and illustration only. A DCF is only as good as its assumptions, and small changes to the growth and discount rates can move the result substantially; its output is an estimate, not a market price or a recommendation. Nothing here is investment, tax, or trading advice.