How to answer “walk me through a DCF”

What the interviewer wants

They aren’t testing whether you can build a model. They want to hear that you understand the logic, can explain it in order, and know where the judgement calls are. Aim for 60 to 90 seconds.

A structure that works

1. The idea. “A DCF values a company as the present value of the cash it will generate in the future.”
2. Project free cash flow. Usually five to ten years of unlevered free cash flow: EBIT, minus taxes, plus depreciation and amortisation, minus capital expenditure, minus the increase in working capital.
3. Work out the terminal value. The value of everything after the forecast, using either a perpetual growth rate or an exit multiple of EBITDA.
4. Discount at the WACC. Discount the cash flows and the terminal value back to today using the weighted average cost of capital.
5. From enterprise value to share price. The sum is enterprise value. Subtract net debt to get equity value, then divide by diluted shares.

The follow-ups to expect

• Why unlevered free cash flow? Because it’s the cash available to all investors, debt and equity, so it matches a discount rate for all investors: the WACC.
• Which matters more, the forecast or the terminal value? Usually the terminal value, often more than half of the total. That’s why small changes in the growth rate move the answer a lot.
• When is a DCF a bad idea? When cash flows are very hard to predict, such as early-stage companies, or for banks, where debt is part of operations.
• What happens if the WACC goes up? The value goes down, because future cash is worth less today.

Common mistakes

• Forgetting to subtract net debt at the end.
• Mixing levered cash flow with the WACC.
• Rambling about formulas instead of giving the steps in order.

Practise saying it out loud against the clock. The DCF unit in the Mandate app drills every follow-up and scores your spoken answer.