How to Build a Discounted Cash Flow Model
Updated: Apr 25, 2021
Before reading this article please read our DCF introduction article here. It covers much of the math you will need.
In order to build a DCF:
1) Project free cash flow to firm and find the present value of the cash flows using the weighted average cost of capital. This is the enterprise value of the business because it is the value of the free cash flow to the entire capital structure (debt & equity).
2) Deduct net debt from enterprise value to find equity value.
3) Divide equity value by shares outstanding to find equity value/share.
We have the following basic financials.
We input these values into our DCF but exclude the interest expense to find EBIT. We multiply EBIT by (tax rate -1) to find the net operating profit after taxes (NOPAT).
We project 5 years forward using % of revenue or another driver which we believe is appropriate.
Next, we turn our attention to the balance sheet.
We also locate Capex in the statement of cash flows.
Using this information we can find the free cash flow to firm by adding back depreciation and amortization, deducting capital expenditures, and increase in net working capital.
Find the present value of the projected free cash flow and the present value of the terminal value. Click here to learn how to calculate terminal value(#4).
Add the values together to find the enterprise value. Deduct net debt and the fair value of non-controlling interest. Divide this value by the number of shares outstanding to find the equity value per share. It is important to use diluted shares outstanding and not just basic shares outstanding. You can learn about how to calculate diluted shares here.