Walk me through a DCF

A discounted cash flow analysis values a company based on the cash it will generate in the future. The logic is simple: a dollar next year is worth less than a dollar today, so you estimate the future cash, then adjust it down to what it's worth now.

This is the most predictable technical question in banking. Nearly everyone gets asked it, and nearly everyone has read the answer somewhere. So the interviewer isn't really checking whether you know the steps — they're checking whether you understand why each step exists, and whether you can explain it clearly while being interrupted.

Start by signposting. Before any detail, say where you're going: "There are four steps — project the cash flows, discount them back, calculate a terminal value, then bridge from enterprise value to equity value." This takes five seconds and makes everything after it easier to follow. Candidates who skip it tend to lose their place halfway through.

Step 1 — Project unlevered free cash flow. Usually five to ten years out. "Unlevered" means before any debt payments — you're valuing the whole business, not just the equity holders' slice. You typically build it up from operating profit: start with EBIT, subtract taxes, add back non-cash charges like depreciation, then subtract capital expenditure and any increase in working capital.

Be ready for: "Why unlevered rather than levered?" The answer is that unlevered cash flow is independent of how the company is financed, which lets you value the business itself and compare it against others with different debt loads.

Step 2 — Discount those cash flows at WACC. WACC is the weighted average cost of capital — essentially the blended return that everyone funding the business, both lenders and shareholders, expects to earn. It's your discount rate because it represents what that money could earn elsewhere at similar risk.

Say what WACC is before you say how it's calculated. Then, if asked: it's the cost of equity weighted by the equity portion of the capital structure, plus the after-tax cost of debt weighted by the debt portion. Cost of equity usually comes from CAPM — risk-free rate, plus beta times the equity risk premium.

Be ready for: "What happens to the valuation if WACC goes up?" Value falls, because you're discounting future cash more heavily.

Step 3 — Calculate terminal value. You can't project forever, so terminal value captures everything beyond your forecast window. Two accepted methods:

• Perpetuity growth: assume cash flows grow at a modest constant rate forever — typically something near long-run GDP or inflation, low single digits.
• Exit multiple: assume the business is sold at the end of the projection period at a multiple of EBITDA, based on where comparable companies trade.

Have a preference and be able to defend it. Perpetuity growth is more theoretically grounded; exit multiple is more grounded in what the market actually pays. Saying "either works" is a weak answer.

Worth knowing: terminal value is usually 60–80% of the total DCF value. It's not a footnote.

Step 4 — Bridge to equity value. Discount the projected cash flows and the terminal value back to today and add them up. That gives you enterprise value — the value of the operating business.

To get to equity value, subtract net debt (debt minus cash) and adjust for other claims like minority interest or preferred stock. Then divide by diluted shares outstanding to get a per-share value, which is usually what the question is ultimately driving at.

Length: aim for roughly ninety seconds before the interviewer interrupts. They will interrupt — that's normal, and the follow-ups are where most of the assessment actually happens.

Can you structure a multi-part answer? Sequencing four steps without backtracking is the same skill that makes someone useful on a live deal.

Do you understand it, or did you memorise it? The follow-ups are designed to find out. Someone who genuinely understands a DCF can explain why unlevered cash flow is used; someone reciting cannot.

Do you stay composed? Interruptions are deliberate. What's being watched is whether you take the question, answer it, and return to your structure.

Reciting without signposting. The most frequent problem. A correct answer with no roadmap still lands as disorganised.

Jumping to the WACC formula. People rush there because it's the bit they've memorised, skipping what discounting is actually for.

Rushing terminal value. It's the majority of the answer's value. Treating it as an afterthought signals you've never built one.

Stopping at enterprise value. Forgetting the equity bridge is extremely common and immediately obvious.

Refusing to take a position. "Either method works" reads as avoidance. Pick one, give a reason, and be prepared to be pushed on it.