How to Build a DCF Model

Building a Discounted Cash Flow (DCF) model is a fundamental task in investment banking, providing an estimate of a company's intrinsic value based on its projected future cash flows. Here’s a detailed, step-by-step guide to constructing a DCF model, covering everything from projecting future cash flows to performing sensitivity analysis.

Step 1: Project Free Cash Flows

Estimating Future Free Cash Flows (FCF)

1. Revenue Projections:
2. Gross Margin and Operating Expenses:
3. Capital Expenditures (CapEx):
4. Working Capital Changes:
5. Tax Rates:

Calculating Unlevered Free Cash Flow (UFCF)

1. EBITDA Calculation:
2. Interest Expense and Taxes:
3. Non-Cash Charges:
4. UFCF Calculation:

Step 2: Calculate the Terminal Value

Estimating Terminal Value

1. Perpetuity Growth Method:
2. Exit Multiple Method:

Discounting Terminal Value

1. Present Value Calculation:

Step 3: Determine the Cost of Capital

Calculating WACC

1. Cost of Equity (CAPM):
2. Cost of Debt:
3. WACC Calculation:

Step 4: Calculate the Enterprise Value

Present Value of Cash Flows

1. Discounting Cash Flows:

Enterprise Value Calculation

1. Summing Present Values:

Step 5: Calculate the Equity Value

1. Net Debt Adjustment:

Step 6: Calculate the Share Price

1. Share Price Determination:
2. Market Comparison:

Step 7: Perform Sensitivity Analysis

Assessing Impact of Assumptions

1. Key Drivers:
2. Scenario Analysis:

Sensitivity Analysis Tools

1. Data Tables and Tornado Charts:

Conclusion

Building a DCF model involves projecting future free cash flows, calculating terminal value, determining the cost of capital, calculating enterprise and equity values, and performing sensitivity analysis. Each step is critical for developing an accurate valuation of a company. By following this structured approach, investment bankers can provide valuable insights into a company's intrinsic value, aiding in informed investment decisions and strategic planning.