DCF Model: Step-by-Step Guide to Building One

A DCF model is a spreadsheet that values a company by forecasting the free cash flow it will generate, discounting that cash flow back to today at the weighted average cost of capital, and adding a terminal value for everything beyond the explicit forecast period. The build has six steps: project unlevered free cash flow, calculate terminal value, discount both at WACC, sum to enterprise value, add cash and subtract debt to reach equity value, then divide by shares for a price per share. This guide walks through the mechanics of each step with formulas, so you can actually construct the model, not just describe it in an interview. For the tight verbal answer interviewers expect, see walk me through a DCF.

What is a DCF model, and what does it compute?

A DCF model computes intrinsic value: what a company is worth based on its own projected cash generation, independent of how comparable companies happen to be priced in the market. Wall Street Prep frames a DCF as the sum of the present values of a company's projected free cash flows plus a terminal value. The output is an enterprise value, which you then convert to equity value and, if you divide by shares outstanding, an implied share price you can compare to where the stock actually trades. Building the model yourself, rather than reciting the framework, is what separates a strong technical interview from a mediocre one.

How do you forecast unlevered free cash flow?

You forecast unlevered free cash flow by starting at operating profit, taxing it, then adjusting for non-cash items and reinvestment, because unlevered cash flow belongs to all capital providers before any financing decisions. Per Wall Street Prep, the formula is:

FCF = EBIT × (1 − t) + D&A − increases in net working capital − CapEx

EBIT is operating profit before interest and taxes, t is the effective tax rate, D&A is depreciation and amortization added back because it's a non-cash charge, an increase in net working capital ties up cash from receivables, payables, and inventory and is subtracted (a decrease frees cash and adds back), and CapEx is capital spending subtracted because it's cash actually leaving the business. CFI's guide typically forecasts five years, using either a simple growth-rate projection for mature companies or a driver-based build (price, volume, market share) for anything that needs more precision. The full walkthrough of building each line is in how to forecast cash flows in a DCF.

How do you calculate terminal value?

Terminal value captures every dollar of cash flow beyond your explicit forecast period, and per CFI it often makes up more than half of a DCF's total value, so getting it wrong swings the whole model. There are two standard methods, and most bankers run both as a cross-check. The Gordon growth (perpetuity growth) method assumes cash flow grows at a constant, modest rate forever:

TV = [FCFₙ × (1 + g)] / (WACC − g)

CFI's worked example: $10 million of final-year cash flow growing at 2 percent against a 15 percent cost of capital gives a terminal value of $10 million divided by (0.15 minus 0.02), or roughly $77 million. The exit multiple method instead applies a market multiple, usually EV/EBITDA from comparable companies, to the final forecast year's metric: in CFI's example, $6.3 million of EBITDA at an 8x multiple gives a terminal value of about $50 million. Because the two methods can diverge, sanity-check the implied growth rate embedded in your exit multiple against the perpetuity growth rate you'd otherwise assume. Full mechanics are in terminal value explained.

How do you discount cash flows using WACC?

You discount both the explicit forecast cash flows and the terminal value using the weighted average cost of capital, since unlevered free cash flow belongs to every capital provider and has to be discounted at the blended rate every provider requires. Per Mergers & Inquisitions, the formula is:

WACC = [E / (D + E)] × rₑ + [D / (D + E)] × r_d × (1 − t)

Cost of equity (rₑ) usually comes from CAPM, cost of debt (r_d) is the company's borrowing rate, and both are weighted by their share of the target capital structure, with the after-tax adjustment on debt because interest is tax-deductible. Each cash flow's present value is:

PV = FCF_t / (1 + WACC)^t

Discount the terminal value the same way, using the final forecast year's exponent, then sum every discounted cash flow and the discounted terminal value to arrive at enterprise value. Breaking Into Wall Street's framing is worth remembering here: more leverage raises the cost of both debt and equity simultaneously, since added risk hits every capital provider, not just one. Full derivation is in WACC explained.

How do you bridge from enterprise value to equity value?

You get equity value by taking enterprise value and adjusting for everything that sits between the company's core operations and its common shareholders. Add back cash and equivalents, since those belong to equity holders and weren't counted in unlevered cash flow; then subtract total debt, preferred stock, and any minority interest, since those claims are paid before common equity. Per CFI, that adjusted figure is the equity value, and dividing by diluted shares outstanding gives price per share.

For the full bridge mechanics and how it compares across valuation methods, see enterprise value vs. equity value.

How do you sanity-check and sensitize a DCF model?

A DCF is only as reliable as its assumptions, so you stress-test it rather than trust a single output. Confirm your terminal growth rate sits below long-run GDP growth and roughly matches your final forecast year's growth trajectory, so the model doesn't imply a company that outgrows the economy forever. Check that CapEx stays above D&A during the growth years, since a maturing business typically still reinvests more than it depreciates. Then build a sensitivity table flexing WACC and terminal growth (or exit multiple) across a realistic range, since those two inputs drive the majority of the output and a single point estimate hides how uncertain the valuation really is. The full sensitivity build is in DCF sensitivity analysis.

What are the most common mistakes when building a DCF model?

The most common error is mismatching cash flow and discount rate: discounting unlevered free cash flow at the cost of equity instead of WACC, which overstates value because it ignores that debt holders also have a claim on that cash. A second common mistake is picking a terminal growth rate above long-term GDP growth, which implies a company that eventually outgrows the entire economy. A third is ignoring the exit multiple's implied growth rate, so the two terminal value methods quietly contradict each other. Catching these errors before you present the model is what separates a credible valuation from one an interviewer or a client will pick apart in the first five minutes.

Sources

• Wall Street Prep, "DCF Model Training: 6 Steps to Building a DCF Model in Excel": https://www.wallstreetprep.com/knowledge/dcf-model-training-6-steps-building-dcf-model-excel/ (checked July 2026)
• Mergers & Inquisitions, "DCF Model: Full Guide, Excel Templates, and Video Tutorial": https://mergersandinquisitions.com/dcf-model/ (checked July 2026)
• Corporate Finance Institute, "DCF Model Training Free Guide": https://corporatefinanceinstitute.com/resources/valuation/dcf-model-training-free-guide/ (checked July 2026)
• Breaking Into Wall Street, "WACC, Cost of Equity, and Cost of Debt": https://breakingintowallstreet.com/kb/discounted-cash-flow-analysis-dcf/wacc-formula/ (checked July 2026)