DCF (Discounted Cash Flow) is the most theoretically rigorous way to value a business. It calculates intrinsic value as the present value of all future free cash flows, discounted at an appropriate rate of return.
Every analyst report uses DCF in some form. Every M&A deal is justified with DCF math. Yet most retail investors never build one.
This guide walks through the 5-step DCF process with a real Indian example — TCS — and shows exactly why DCF is so sensitive to assumptions.
The DCF Process — 5 Steps
Project Free Cash Flows for the next 5-10 years
Calculate WACC — the appropriate discount rate
Discount each year's cash flow to present value
Calculate terminal value using Gordon Growth Model
Sum everything, subtract net debt, divide by shares for per-share intrinsic value
Step 1: Project Free Cash Flows
Free Cash Flow to the Firm (FCFF) is cash available to all capital providers after the company has invested for its own growth.
Project growth rates that DECLINE over time — high growth rarely sustains 10+ years. Use management guidance, historical 5-10 year averages, and industry growth rates as inputs.
Step 2: Calculate WACC
WACC = (E/V × Re) + (D/V × Rd × (1 − Tax))
For TCS (largely debt-free), WACC ≈ Cost of Equity = 12% (using Risk-free 7% + Beta 0.7 × ERP 7%). For a company with 30% debt/equity split, WACC ≈ (0.7 × 12%) + (0.3 × 9% × 0.75) ≈ 10.4%.
Discount TV back to present: 10,20,771 / 1.12⁴ = ₹6,49,210 Cr
Sensitivity Warning:
Change terminal growth from 5% to 6% → TV jumps from ₹10.2 lakh Cr to ₹12.0 lakh Cr (+18%). Change WACC from 12% to 11% → TV jumps to ₹11.9 lakh Cr (+17%). DCF results swing dramatically with small assumption changes.
Step 5: Per-Share Intrinsic Value
Component
Value (₹ Cr)
PV of explicit FCF (Years 1-5)
1,81,788
PV of Terminal Value
6,49,210
Enterprise Value
8,30,998
Add: Net Cash (cash − borrowings)
60,000
Equity Value
8,90,998
Shares outstanding (Cr)
366
Intrinsic value per share
₹2,435
If TCS trades at ₹3,500, our DCF says ~30% overvalued. If at ₹2,000, ~22% undervalued. Apply margin of safety before buying.
Common DCF Mistakes
Optimistic growth assumptions: Projecting 15-20% growth for 10 years rarely holds. Reality reverts to 7-10% for mature businesses.
Terminal growth too high: Cap at long-term nominal GDP (~6-7% for India). Never exceed WACC, or model breaks.
Wrong WACC: Using book value of equity instead of market value distorts capital structure weights.
False precision: "Intrinsic value is exactly ₹2,435.23." No — report a range like ₹2,100-₹2,800 based on sensitivity.
DCF for unsuitable companies: Banks, cyclical commodity producers, early-stage startups — use relative valuation instead.
Pro Tip — Sensitivity Tables:
Always run sensitivity analysis: ±2% WACC and ±2% terminal growth. You will see fair value range from ₹1,800 to ₹3,200, not a single point. That is honest — fair value IS a range.
Build Your Own DCF — Free Calculator
Plug in your own FCF projections, growth rates, and WACC. See how intrinsic value changes with each assumption.
DCF (Discounted Cash Flow) valuation calculates intrinsic value of a business as the sum of all future free cash flows, discounted back to today's value using an appropriate discount rate (usually WACC — Weighted Average Cost of Capital). The 5-step process: (1) Project free cash flows for the next 5-10 years using realistic growth assumptions; (2) Calculate WACC using cost of equity and cost of debt; (3) Discount each year's cash flow to present value; (4) Calculate terminal value using Gordon Growth Model; (5) Sum everything for enterprise value, then subtract net debt for equity value, divide by shares outstanding for per-share intrinsic value.
WACC = (E/V × Re) + (D/V × Rd × (1 − Tax)). Where E = market value of equity, D = market value of debt, V = E + D, Re = cost of equity (typically 12-15% for Indian listed companies), Rd = cost of debt (typically 7-10% pre-tax), Tax = corporate tax rate (25% under new regime). Cost of equity uses CAPM: Re = Risk-free rate + Beta × Equity risk premium. For India: Risk-free ~7% (10-year G-Sec), ERP 7-8%. Most Indian large-caps have WACC of 10-13%.
Terminal value (TV) represents the value of all cash flows beyond your explicit forecast period. It typically accounts for 60-80% of total DCF value. Gordon Growth Model: TV = CF_year(n+1) / (WACC − g), where g = perpetual growth rate (cap at long-term nominal GDP ~6-7% for India). Then discount TV back to present. A 1% change in terminal growth rate can swing fair value by 15-25% — be conservative.
Free Cash Flow to the Firm (FCFF) = EBIT × (1 − Tax) + Depreciation − Capital Expenditure − Change in Working Capital. This is cash available to all capital providers (equity + debt) after the company has invested for its own growth. Most DCF models use FCFF discounted at WACC to arrive at enterprise value, then subtract net debt for equity value. Use the company's annual report cash flow statement and Screener.in's 10-year FCF history as inputs.
DCF compounds small assumption changes over 10+ years, amplifying errors. Three major sensitivities: (1) Growth rate during forecast period — projecting 15% vs 12% growth over 10 years changes terminal cash flow by 35%; (2) Discount rate (WACC) — changing 11% to 10% increases PV by ~10% on long-duration cash flows; (3) Terminal growth rate — changing 4% to 5% increases TV by 30-40%. Always run sensitivity tables and report fair value RANGES, not single point estimates.
DCF works best for stable, mature businesses with predictable cash flows. AVOID DCF for: (1) Early-stage companies with no positive FCF history; (2) Cyclical commodity companies (steel, oil, sugar) — single-year FCF doesn't represent normalised cycle; (3) Financial companies (banks, NBFCs, insurance) — use P/B + ROE-based framework instead; (4) Distressed companies — uncertainty too high; (5) Real estate developers — project-based cash flows don't fit perpetual growth model. For these, use relative valuation (PE, P/B, EV/EBITDA, P/Sales) or asset-based methods.
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