FIN435 • DCF Basics • Chapter 3 + Chapter 12

DCF Basics: From Free Cash Flow to Project Cash Flow to NPV

This page introduces the basic logic of discounted cash flow (DCF), from free cash flow and discounting to project cash flow, NPV, Monte Carlo analysis, and the Chapter 12 case.

Open My FCF Calculator Part II Files

Page structure

Part I (Chapter 3): DCF basics, FCF, discounting, terminal value, enterprise value, and equity value
Part II (Chapter 12 case): project cash flow, NPV, Monte Carlo, files, and videos

Part I — Chapter 3: Basic DCF explanation

Discounted Cash Flow (DCF) is a valuation method based on one simple idea: an asset is worth the present value of the cash flows it will generate in the future.

Value = Present Value of Expected Future Cash Flows

Main idea: money received in the future is worth less than money received today, so future cash flows must be discounted back to the present.

Key topics in this part

What free cash flow (FCF) means
Why FCF is used in valuation instead of accounting income
How to discount cash flows using WACC
How terminal value works
How to move from enterprise value to equity value

Basic firm valuation flow

Estimate future free cash flows.
Discount those FCFs back to today.
Add a terminal value if the firm continues beyond the forecast period.
The result is enterprise value.
Add cash and subtract debt to get equity value.
Divide by shares outstanding to get value per share.

Key valuation equations

FCF = EBIT(1 − T) + Depreciation − CapEx − ΔNOWC

Enterprise Value = PV of forecast FCFs + PV of Terminal Value

Equity Value = Enterprise Value + Cash − Debt

Stock Price = Equity Value / Shares Outstanding

Why DCF matters

It connects valuation directly to cash generation.
It emphasizes growth, risk, and timing.
It shows why valuation depends on assumptions as well as formulas.

Free cash flow video

Open on YouTube My FCF Calculator

DCF video — connect FCF to valuation

Open on YouTube

After free cash flow is understood, the next step is to see how DCF converts those future cash flows into a value today.

FCF measures how much cash a business generates.
DCF measures what those future cash flows are worth today.
WACC is used to discount firm-level cash flows.
Terminal value captures value beyond the explicit forecast period.

Big picture

Forecast cash flows → Discount at WACC → Add terminal value → Get enterprise value → Move to equity value

DCF basics — what each input means

Main inputs in a DCF model

Input	Meaning	Why it matters
Free Cash Flow (FCF)	Cash flow available to all capital providers	This is the core cash flow being valued.
WACC	Weighted average cost of capital	This is the discount rate for firm-level FCF.
Growth rate	Expected future increase in FCF	Growth assumptions strongly affect valuation.
Terminal value	Value beyond the explicit forecast horizon	Often a large part of total value.
Cash and debt	Non-operating cash and financing claims	Needed to move from enterprise value to equity value.
Shares outstanding	Total shares of stock	Used to convert equity value into value per share.

Basic DCF workflow

Start with a current or recent FCF value.
Forecast FCF for several years.
Choose a discount rate, usually WACC.
Discount each forecast cash flow.
Estimate terminal value.
Add the PV of forecast cash flows and terminal value.
Move from enterprise value to equity value.
Divide by shares outstanding if estimating price per share.

Why each input matters

FCF: measures real cash generation, not just accounting profit.
WACC: reflects the required return for the firm’s investors.
Growth: changes future cash flow size and often drives valuation differences.
Terminal value: captures continuing value after the forecast period.
Cash and debt: adjust operating value into shareholder value.

Important point

A DCF model is not just plugging numbers into a formula. It is a way to organize thinking about cash flow, risk, and growth.

Different assumptions can produce different values.
That does not automatically make one model wrong.
What matters is whether the assumptions are reasonable and clearly explained.

Page note

This page focuses on the DCF process and a Chapter 12 case application.

One-stage DCF — stable growth starts immediately

Use this when: the firm is already in a mature, stable-growth stage.

FCF₁ = FCF₀(1 + g)

Enterprise Value = FCF₁ / (WACC − g)

Equity Value = Enterprise Value + Cash − Debt

Estimated Stock Price = Equity Value / Shares Outstanding

Main steps

Start with the most recent FCF₀.
Choose a long-run growth rate g.
Use WACC as the discount rate.
Compute enterprise value with the growing perpetuity formula.
Add cash and subtract debt.
Divide by shares outstanding if a per-share value is needed.

Limitation: this model may undervalue a fast-growing firm if it assumes mature growth too early.

Two-stage DCF — growth first, maturity later

Use this when: the company can grow faster for several years before settling into stable growth.

Forecast FCF year by year during the high-growth period

PV of Stage 1 = Σ [FCF_t / (1 + WACC)^t]

Terminal Value at Year N = FCF_N+1 / (WACC − g_terminal)

Enterprise Value = PV of Stage 1 + PV of Terminal Value

Equity Value = Enterprise Value + Cash − Debt

Main steps

Choose a high-growth rate for the first stage.
Choose the number of high-growth years.
Forecast FCF for each of those years.
Discount each forecast FCF at WACC.
Use a lower terminal growth rate after maturity.
Compute terminal value, discount it, and move to equity value and price per share.

Main idea: two-stage DCF is often more realistic for firms that are still expanding significantly.

Why compare one-stage and two-stage models?

A one-stage model is simpler and easier to use.
A two-stage model better captures the idea that strong firms may grow faster before maturing.
For younger or faster-growing firms, valuation differences often come more from growth assumptions than from small changes in WACC.

Useful comparison questions

Which model fits the company better, and why?
How sensitive is the estimate to the growth rate?
How sensitive is the estimate to WACC?
Why might intrinsic value differ from the observed market price?

DCF worksheet structure

This worksheet layout can be used for a company-specific DCF exercise.

Input	Value	Source / explanation
Most recent FCF	__________	Public FCF source
Forecast period	__________	Number of years forecasted
Growth assumption(s)	__________	Assumption with explanation
WACC	__________	Discount rate used
Terminal growth rate	__________	Long-run growth assumption
Enterprise value	__________	DCF calculation
Cash	__________	Balance sheet input
Debt	__________	Balance sheet input
Equity value	__________	Enterprise value + cash − debt
Shares outstanding	__________	If needed for per-share value
Estimated price per share	__________	Calculated value

Mini DCF example — simple version

Purpose: a small example to show the logic of DCF without needing a real company.

Assume

FCF in Year 1 = $100
FCF in Year 2 = $110
FCF in Year 3 = $121
WACC = 10%
Terminal growth after Year 3 = 3%

Discount the forecast cash flows

PV(Year 1 FCF) = 100 / 1.10

PV(Year 2 FCF) = 110 / 1.10²

PV(Year 3 FCF) = 121 / 1.10³

Terminal value at Year 3

TV₃ = FCF₄ / (WACC − g)

FCF₄ = 121(1.03) = 124.63

TV₃ = 124.63 / (0.10 − 0.03)

Main takeaway

The forecast period captures the first few years directly.
The terminal value captures all value after the explicit forecast horizon.
Most DCF models are highly sensitive to the terminal growth rate and WACC.

⭐ Part II — Chapter 12 Case: Project Cash Flow, NPV, Monte Carlo, File, and Videos

This section contains the Chapter 12 case inputs, file, and video walkthroughs.

Case overview

Project cash flow setup
NPV, IRR, MIRR, PI, payback, and discounted payback
Monte Carlo simulation
Excel case file and video walkthroughs

Workbook structure

Tab 1: Inputs and assumptions
Tab 2: Depreciation and operating cash flow
Tab 3: NOWC, salvage, and total project cash flows
Tab 4: NPV metrics and Monte Carlo output

Case information

Initial investment and operating assumptions

Item	Value
Cost of new equipment	$500,000
Shipping and installation	$40,000
Required increase in NOWC at t = 0	$30,000
Project life	4 years
Tax rate	25%
Required return / WACC	10%
Expected salvage value in Year 4	$80,000

Operating cash flow setup

Item	Value
Annual unit sales	5,000
Selling price per unit	$70
Variable cost per unit	$42
Annual fixed operating costs	$60,000
Depreciation method	Straight-line
Depreciable basis	Equipment + shipping/installation
NOWC recovery	Recovered in final year

Core formulas

OCF = (Sales − Operating Costs − Depreciation)(1 − T) + Depreciation

NPV = Σ [FCF_t / (1 + r)^t] − Initial Outlay

Final Year Cash Flow = OCF + After-Tax Salvage + Recovery of NOWC

Monte Carlo setup

Select key uncertain inputs such as unit sales, selling price, variable cost, and salvage value.
Assign distributions or ranges to those inputs.
Run repeated simulations to generate a distribution of NPVs.
Review average NPV, downside probability, and the spread of outcomes.

Part II files and videos

Case file

Chapter 12 case workbook for Spring 2026.

chapter12_case_questions_spring_2026.xlsx

Download Excel File

Case video — Part I

Open Video

Case video — Part II

Open Video

Case-study quizzes

Quiz 1

DCF and FCF true/false quiz

Open Quiz 1

Quiz 2

NPV, IRR, and MIRR true/false quiz

Open Quiz 2