How to Value a Company in 26 Minutes
A company is worth the cash it will generate in the future, translated into today's money. In a discounted cash flow valuation you forecast free cash flows for a few years, add a terminal value for everything after, discount it all back, then subtract debt to see what the shares are worth.
How to value a company, explained simply
To value a company with a DCF, discount a few years of forecast free cash flow plus a terminal value at the WACC, subtract net debt and divide by the number of shares. In the example, that gives about $25.97 per share, and about 83% of the value comes from the terminal value.
What this company valuation lesson covers
- Why a company's value is the present value of its future cash flows
- How to discount a few years of forecast free cash flow
- How a growing-perpetuity terminal value captures the long run
- How to move from enterprise value to equity value per share
- Where multiples like P/E fit as a quick sanity check
DCF valuation formulas, explained
- FCFₜ
- Free cash flow in year t
- WACC
- Weighted average cost of capital
- TV_N
- Terminal value at the end of the forecast, year N
- g
- Long-run constant growth rate, which must be below WACC
- Net debt
- Debt minus cash
How to value a company step by step (worked example)
A firm expects free cash flow of $100, $110 and $120 million in Years 1 to 3, then 3% growth forever. WACC is 10%, net debt is $300 million and there are 50 million shares. Value each share.
- PV of forecast FCF = 100 ÷ 1.1 + 110 ÷ 1.1² + 120 ÷ 1.1³ ≈ 90.91 + 90.91 + 90.16 = 271.98
- Terminal value at Year 3 = 120 × 1.03 ÷ (0.10 − 0.03) ≈ 1,765.71
- PV of terminal value = 1,765.71 ÷ 1.1³ ≈ 1,326.61
- Firm value ≈ 271.98 + 1,326.61 = 1,598.58
- Equity value ≈ 1,598.58 − 300 = 1,298.58, so per share ≈ 1,298.58 ÷ 50 ≈ 25.97
Answer: About $25.97 per share (figures in millions, rounded to 2 decimals). Note that the terminal value is roughly 83% of the firm value.
DCF vs valuation multiples
| DCF (discounted cash flow) | Multiples (P/E, EV/EBITDA) | |
|---|---|---|
| What it uses | Forecast cash flows and a discount rate | Prices of similar companies |
| Strength | Built on the company's own cash | Quick and grounded in the market |
| Weakness | Very sensitive to growth and WACC guesses | Copies any mispricing in the comparables |
| Best for | Understanding what drives value | A fast sanity check |
Does 'growth forever' make sense anymore? David's take
In the example, 83% of the company's value comes from one assumption: cash grows 3% a year forever. Forever is a strange word when product lifecycles go from 50 years to 50 months to 50 weeks. That's a catchy line, not a statistic, but the direction is real. Keep the same numbers but let the cash stop 10 years after Year 3, and the share drops from $25.97 to $12.22. If it stops after 5 years, it's worth $6.87. Do the textbook valuation, then ask how long 'forever' really is.
From David's concept: Guerrilla Producting (product lifecycle compression). This is David's opinion, alongside the standard textbook answer above.
Harder company valuation questions
How much does the share price change with the growth rate?
Keeping WACC at 10%: at 2% growth the share is worth about $22.43, at 3% about $25.97, and at 4% about $30.69. One percentage point of long-run growth moves the value by roughly 14 to 18%.
What happens if WACC is 9% or 11% instead of 10%?
At 9% the share is worth about $31.35; at 11%, about $21.94 (growth kept at 3%). Small changes in the discount rate move a DCF a lot, so always show a range.
What multiple does the terminal value imply?
The terminal value of $1,765.71 is about 14.7 times Year 3 free cash flow of $120. Checking that against what similar companies trade at is a quick way to spot an unrealistic growth rate.
Common company valuation questions
What are the main ways to value a company?
The three common approaches are discounted cash flow (present value of future cash flows), relative valuation using multiples of similar companies such as P/E or EV/EBITDA, and asset-based valuation. Students are usually tested on DCF and dividend-based models, with multiples as a cross-check.
What is the difference between enterprise value and equity value?
Enterprise value is what the whole business is worth to all its investors, lenders and owners together. Equity value is what is left for shareholders after you subtract net debt. Divide equity value by shares outstanding to get a value per share.
Why is the terminal value so large in a DCF?
It captures every cash flow after the forecast period, which is often decades of business. That is why small changes in the growth rate or the discount rate can swing the final answer a lot. Always test a few different assumptions.
What discount rate do you use to value a company?
When you discount free cash flow to the whole firm, you use the weighted average cost of capital, because those cash flows belong to both lenders and shareholders. When you discount dividends or cash flow to equity, you use the cost of equity instead.