"Walk me through a DCF model."
The DCF is the foundation of valuation in investment banking and corporate finance. Interviewers use this to test your understanding of fundamental valuation principles.
Start with projecting free cash flows for 5-10 years.
Explain how you calculate the discount rate (WACC).
Describe terminal value calculation (Gordon Growth or Exit Multiple).
Discount everything back to present value.
A DCF values a company by discounting its future free cash flows to present value. Step 1: Project unlevered free cash flows for 5-10 years using revenue growth, margins, CapEx, and working capital assumptions. Step 2: Calculate WACC as the blended cost of equity (via CAPM) and after-tax cost of debt, weighted by target capital structure. Step 3: Calculate terminal value — I typically use both Gordon Growth Model (FCF × (1+g)/(WACC-g)) and Exit Multiple method, then cross-reference. Terminal value often represents 60-80% of total value. Step 4: Discount all cash flows and terminal value back to today using WACC. Sum them for enterprise value, subtract net debt to get equity value, divide by shares for per-share value. I always run sensitivity tables on growth rate and WACC.
Practice walking through each step fluently — pausing suggests weak understanding.
Know common pitfalls: double-counting growth, wrong FCF calculation, unrealistic terminal assumptions.
Be ready to discuss when DCF works well versus when comparable methods are better.
Sensitivity to assumptions. Small changes in growth rate or WACC dramatically affect the output. Terminal value dominates the result. Always present a range, not a single number.
For early-stage companies with no positive cash flows, distressed companies, banks (use dividend discount model instead), and companies with highly unpredictable cash flows.
Gordon Growth is more theoretically sound but sensitive to the growth rate assumption. Exit Multiple is more market-based but assumes current multiples persist. Best practice is to use both and triangulate.
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