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Lesson 7 of 9 · 14 min
The DCF process: discount rates, terminal values and ranges
A DCF valuation follows five steps: choose the cash flow, forecast it, discount it at the rate that matches whose cash it is, add a terminal value, and turn the result into a point estimate or range to compare with the price.
In short
- Five steps: cash flow measure → forecast → discount rate → terminal value → point estimate or range.
- Cash to shareholders (dividends, FCFE, RI) is discounted at ; FCFF at WACC. FCFF gives firm value: subtract the market value of debt to get equity.
- WACC ≤ ; they are equal only without debt. Discounting FCFE at WACC overstates value.
- Consistent FCFE and FCFF models should give similar equity values; a big gap means the assumptions need revisiting.
- The terminal value weighs more with a shorter horizon; its growth rate usually lies between expected inflation and nominal GDP growth, using long-run averages for the markets where the firm sells.
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