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Advanced3 min readValuing Stocks · 8/11

A Step-by-Step DCF Worked Example

The previous lesson covered the idea behind DCF. Here we walk through a full calculation for an invented company, with simple numbers, from year one to a value per share. At the end we see how a small change in one assumption changes the result.

What you will learn

  • Follow the steps of a DCF calculation in order.
  • Calculate the terminal value and discount it.
  • See for yourself how sensitive the result is to the discount rate.
The lesson as a short video · 27 seconds · Watch on YouTube
In this lesson
  1. The inputs
  2. The steps
  3. Change one assumption
  4. Check yourself
  5. Summary
  6. Related terms

The inputs

Free cash flow to the firm (FCFF)EGP 100 million in year one, growing 10% a year: 110, then 121.
Discount rate (WACC)The weighted average cost of capital, 20% a year.
Growth after year three5% a year, indefinitely.
Net debt and sharesNet debt of 120 million and 50 million shares.

Because we discount the cash flows of the whole firm at WACC, the result is the enterprise value, which is why net debt is subtracted at the end. Discounting free cash flow to equity (FCFE) at the cost of equity would give the equity value directly.

The steps

  1. Discount each yearYear one ÷ 1.20, year two ÷ 1.44 (that is 1.20 × 1.20), year three ÷ 1.728. The results: 83.33, 76.39 and 70.02.
  2. Calculate the terminal valueYear-four cash = 121 × 1.05 = 127.05. Terminal value = 127.05 ÷ (0.20 − 0.05) = 127.05 ÷ 0.15 = 847.
  3. Discount the terminal valueIt is valued at the end of year three, so it is discounted like year three: 847 ÷ 1.728 = 490.16.
  4. Add up83.33 + 76.39 + 70.02 + 490.16 = 719.90 million. That is the enterprise value estimate.
  5. Subtract net debt and divide719.90 − 120 = 599.90 million for shareholders. ÷ 50 million shares = about EGP 12 per share.
Year 1100 ÷ 1.2083.33
Year 2110 ÷ 1.4476.39
Year 3121 ÷ 1.72870.02
Terminal value847 ÷ 1.728490.16
Enterprise value719.90
Minus net debt− 120
Per share (50M shares)599.90 ÷ 50≈ 12.00
Figures in EGP millions, at a 20% discount rate
The whole calculation in one picture.

Notice that the terminal value alone is about 490 of 720, roughly 68% of the total. Most of the value comes from an assumption about distant years.

Change one assumption

Keep everything else the same and change only the discount rate. At 18% the estimate comes to about 14.24 per share; at 22%, about 10.28. Two points in one assumption moved the result about 19% up or 14% down.

Discount rate 18%
14.24
Discount rate 20%
12.00
Discount rate 22%
10.28
Same company, three discount rates, three estimates.
Watch outThe growth rate in the terminal value must be below the discount rate, or the formula produces a meaningless number. And the EGP 12 here is not a price target; it is only the result of these exact assumptions.

Try it with a real company

Pick a company, read its basic figures and try different assumptions. What you learn from the spread of results matters more than any single number.

Browse stocks

Check yourself

1. Year-four cash 60 million, discount rate 15%, growth 5%. What is the terminal value?

60 ÷ (0.15 − 0.05) = 60 ÷ 0.10 = 600 million.

2. EV 900 million, net debt 100 million, 40 million shares. Value per share?

(900 − 100) ÷ 40 = 800 ÷ 40 = 20.

Summary

  • Discount FCFF at WACC, add the discounted terminal value, subtract net debt, divide by shares.
  • The terminal value is usually the largest part of the result.
  • A small change in the discount rate or growth moves the estimate a lot.

Related terms

Fair valueMarket cap

Related lessons

Valuing StocksWhat Is a Stock's Fair Value, and Why Does It Differ from the Price?Trading and Investing StrategiesScenario Analysis: Several Possibilities Instead of One Forecast
Previous · 07Discounted Cash Flow (DCF): The Idea, SimplyNext · 09The Dividend Discount Model (DDM)

Educational content only, not investment advice. Companies and figures in the examples are invented for illustration.