Walk me through a DCF (Explained): Interview Answer Guide 2027
This dcf interview question is asking for the core idea of intrinsic valuation: a DCF estimates what a company is worth today by projecting its future free cash flows and discounting them back to the present at a rate reflecting risk. The three building blocks are the cash flow forecast, the terminal value, and the discount rate (WACC).
What This DCF Interview Question Tests
A discounted cash flow (DCF) analysis values a company based on the cash it is expected to generate in the future, not on what similar companies trade for today.
Building a DCF means assembling three pieces. First, you forecast unlevered free cash flow — typically for five to ten years — from revenue growth, margins, capital expenditure, and working capital assumptions. Second, you estimate a terminal value capturing everything beyond the forecast period, either with a perpetuity growth formula or an exit multiple.
How to Answer This DCF Interview Question
Open with one crisp sentence: a DCF values a company by discounting its projected future free cash flows to the present. Then walk the three steps in order, spending the most time on the terminal value since that is where most of the value usually sits.
Common Mistakes on the DCF Interview Question
- Stopping at enterprise value. A DCF produces enterprise value; the interviewer wants equity value per share, so you must subtract net debt (and adjust for minority interest and other claims where relevant) before dividing by shares outstanding.
- Discounting at the wrong rate. Unlevered free cash flow gets discounted at WACC. Discounting it at the cost of equity instead is a classic error — cost of equity belongs to levered (equity) cash flows.
- An impossible terminal growth rate. Perpetuity growth above long-run nominal GDP growth implies the company eventually becomes larger than the economy. Keep it at or below that ceiling or your answer loses credibility.
This is the kind of technical question that commonly decides interview rounds — candidates report that one hesitant or rambling answer here can end the process on the spot. Practice saying your answer out loud until it sounds calm, structured, and confident.
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FAQ
Why do you discount free cash flow at WACC instead of the cost of equity?
Unlevered free cash flow belongs to all capital providers — both debt and equity holders — so it must be discounted at the blended cost of both, which is WACC. Cost of equity is only correct for levered cash flows that belong to shareholders alone.
What are the two terminal value methods, and which is better?
The perpetuity growth method assumes cash flows grow forever at a stable rate; the exit multiple method applies an EV/EBITDA multiple in the final year. Neither is universally better — practitioners often compute both and compare as a sanity check.
Why is a DCF called an intrinsic valuation?
Because it derives value from the company's own expected cash flows rather than from market prices of comparable companies. That makes it independent of market sentiment, but also entirely dependent on your assumptions.
How sensitive is a DCF to its inputs?
Extremely — small changes in WACC or terminal growth can swing the output by 20% or more, since the terminal value often represents most of the total. Always present a sensitivity table rather than a single point estimate.
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