{"concept_id":"ALTSS-VAL-013","slug":"discounted-cash-flow","canonical_name":"Discounted Cash Flow","acronym":"DCF","aliases":["DCF","DCF model"],"kind":"process","authority":"industry","facets":["VAL"],"domains":["VALUATION"],"display_title":"Discounted Cash Flow (DCF)","search_aliases":["what is discounted cash flow","dcf valuation explained","dcf formula","terminal value dcf","wacc in dcf","dcf private equity valuation","dcf example"],"one_sentence_definition":"Discounted cash flow (DCF) analysis is a valuation method that sets an asset's value equal to the present value of its expected cash flows, discounted for timing and risk, including a terminal value for flows beyond the forecast period.","plain_english":"A business is worth the cash it will produce, adjusted for when that cash arrives and how uncertain it is. A DCF forecasts the cash year by year, estimates a lump-sum value for everything after the forecast, and converts both into today's money with a discount rate. Small changes to the growth or discount rate assumptions can move the answer a long way.","parent_concepts":[],"child_concepts":[],"related_concepts":["wacc","enterprise-value","comparable-company-analysis","ipev-valuation-guidelines","calibration","fair-value","leveraged-buyout"],"comparison_concepts":[],"not_the_same_as":[{"slug":"comparable-company-analysis","distinction":"Comps value a business relative to market prices of peers; DCF values it from its own forecast cash flows."},{"slug":"irr","distinction":"IRR is the discount rate that sets the present value of a set of cash flows to zero; DCF applies a required rate to cash flows to find a value."},{"slug":"enterprise-value","distinction":"Enterprise value is the amount a DCF of free cash flow to the firm produces; DCF is one method of estimating it."}],"formula_ids":["F-VAL-013-enterprise-value-from-unlevered-free-cash-flow","F-VAL-013-terminal-value-gordon-growth","F-VAL-013-weighted-average-cost-of-capital"],"worked_examples":[{"title":"Illustrative valuation, step 1: discount rate","paragraphs":["Target capital structure: equity 600, debt 400. Cost of equity 12%, pre-tax cost of debt 7%, tax rate 25%. WACC = 0.6 × 12% + 0.4 × 7% × 0.75 = **9.3%**."],"calc":{"fn":"wacc","inputs":{"equity":600,"debt":400,"cost_equity":0.12,"cost_debt":0.07,"tax_rate":0.25},"expected":{"wacc":0.093},"tol":0.0005}},{"title":"Step 2: terminal value","paragraphs":["Year-5 free cash flow is $13.0m and is expected to grow 2.5% a year thereafter. Terminal value at the end of year 5 = 13.0 × 1.025 / (9.3% − 2.5%) = **$196.0m**."],"calc":{"fn":"gordon_terminal_value","inputs":{"final_year_cash_flow":13,"discount_rate":0.093,"growth":0.025},"expected":{"terminal_value":195.9559},"tol":0.001}},{"title":"Step 3: enterprise value and sensitivity","paragraphs":["Forecast free cash flows of $10.0m, $11.0m, $12.0m, $12.5m and $13.0m have a present value of $44.6m at 9.3%. The terminal value is worth $125.6m today. Enterprise value is **$170.3m**, of which 74% comes from the terminal value. With debt of $60m and cash of $8m, equity is $118.3m.","Enterprise value ($ millions) for other assumptions:","| Discount rate \\ g | 1.5% | 2.5% | 3.5% |\n|---|---|---|---|\n| 8.3% | 176.1 | 200.1 | 234.0 |\n| 9.3% | 153.1 | 170.3 | 193.4 |\n| 10.3% | 135.3 | 148.1 | 164.7 |","A one-point change in either input alone moves value by about 10% to 18%; changing both at once moves it by up to 37%. That is why DCF results are reported with their sensitivities."],"calc":{"fn":"dcf","inputs":{"cash_flows":[10,11,12,12.5,13],"discount_rate":0.093,"terminal_value":195.9559},"expected":{"pv_explicit":44.6392,"pv_terminal":125.6196,"value":170.2589},"tol":0.001}}],"sections":[{"heading":"Steps","paragraphs":["1. Forecast unlevered free cash flow until the business reaches a steady state: EBITDA less cash taxes on operating profit, capital expenditure and investment in working capital.\n2. Choose a discount rate consistent with the cash flows: [WACC](/glossary/wacc) for cash flow to the firm, the cost of equity for cash flow to equity; nominal with nominal, real with real.\n3. Estimate a terminal value by a growth formula or an exit multiple.\n4. Discount everything to the valuation date and sum to [enterprise value](/glossary/enterprise-value).\n5. Bridge to equity and test the result against market-based methods."]},{"heading":"The discount rate","paragraphs":["The discount rate should capture the risk in the projections, and only once: a cautious forecast discounted at a high rate double-counts risk. For fair value measurement, the [IPEV Valuation Guidelines](/glossary/ipev-valuation-guidelines) suggest calibrating at entry: the rate implied by the transaction price can be split into its WACC components plus a company-specific premium, and at later dates the components are updated to current market conditions while the company-specific part is reassessed."]},{"heading":"The terminal value","paragraphs":["The terminal value usually dominates the result, as in the example. A growth-based terminal value needs a growth rate the business can sustain indefinitely (often close to long-term inflation) and a discount rate clearly above it. An exit-multiple terminal value imports today's market pricing into a future year. The IPEV Guidelines describe both and note that, for equity, small changes in terminal assumptions can materially change the value, while for debt the terminal amount is usually contractually fixed."]},{"heading":"DCF in private-markets valuation","paragraphs":["The IPEV Guidelines distinguish two uses. A DCF of the investee company's cash flows produces an enterprise value that is then bridged to the fund's securities; because it needs detailed forecasts, a terminal value and a discount rate, all judgement-heavy, it is most often used to corroborate market-based marks. A DCF of the investment's own cash flows suits debt, mezzanine and other instruments whose value comes from contractual payments, and situations where a sale is imminent and its price substantially agreed. Debt investments are generally valued by yield analysis: the spread implied at entry is compared with market spreads and updated for credit quality and market conditions. For infrastructure, models of cash flow to equity and dividend discount models are the same technique under other names. Accounting standards set no hierarchy among techniques; the US fair value standard, Accounting Standards Codification (ASC) 820, groups DCF under the income approach."]},{"heading":"How GPs, LPs and lenders use DCF","paragraphs":["GPs use DCF-style models to underwrite investments; a [leveraged buyout](/glossary/leveraged-buyout) model is a DCF that solves for the equity return at an assumed exit multiple rather than for value at a required return. Real asset and infrastructure investors rely on DCF because contracted cash flows can be forecast with more confidence. Lenders run downside cash-flow cases to size debt. LPs see DCF most often as a cross-check in GP valuation reports; valuing a fund interest by DCF of the fund's own cash flows is a fallback the IPEV Guidelines expect to be rare."]}],"classification_rules":[],"calculation_rules":[],"common_mistakes":["Using a terminal growth rate at or above the discount rate, which makes the formula meaningless.","Mixing nominal cash flows with a real discount rate, or the reverse.","Discounting cash flow after interest at WACC, or cash flow before interest at the cost of equity.","Building risk into both the forecast and the discount rate.","Accepting a terminal value that implies an exit multiple far from where comparable companies trade.","Presenting a single point estimate without the sensitivity to discount rate and growth."],"edge_cases":["Early-stage companies with negative cash flows are better valued with scenario-based methods than a single-path DCF.","Where leverage will change substantially over the forecast, a constant WACC is an approximation; adjusted present value methods separate the value of financing.","Cyclical businesses need a terminal year that reflects normal, not peak or trough, conditions."],"external_standard_mappings":[],"source_ids":["SRC-IPEV-2025","SRC-US-FASB-ASU-2011-04"],"citations":[{"source_id":"SRC-IPEV-2025","pinpoint":"Section I 2.6 (calibration of discount rate), 3.3, 3.7, 3.8 (terminal value; debt investments), 4.4; Section II 5.16","supports":"Uses and limits of DCF in private capital valuation, terminal value methods, calibration of discount rates, debt yield analysis, infrastructure terminology","source":{"source_id":"SRC-IPEV-2025","title":"International Private Equity and Venture Capital Valuation Guidelines (2025 edition)","authors":"IPEV Board","publisher":"IPEV","document_type":"standard","url":"https://www.privateequityvaluation.com/Portals/0/Documents/Guidelines/2025%20IPEV%20Valuation%20Guidelines.pdf","year":2025,"publication_date":"Published 11 December 2025; in effect for quarterly reporting periods beginning on or after 1 April 2026; early adoption encouraged","jurisdiction":"intl","status":"Current; supersedes the December 2022 edition","last_verified":"2026-10-01"}},{"source_id":"SRC-US-FASB-ASU-2011-04","pinpoint":"ASC 820-10-35-24A; Master Glossary 'Present Value'","supports":"Income approach as one of three valuation approaches; present value technique","source":{"source_id":"SRC-US-FASB-ASU-2011-04","title":"ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs","publisher":"Financial Accounting Standards Board","document_type":"standard","url":"https://storage.fasb.org/ASU2011-04.pdf","publication_date":"May 2011","jurisdiction":"US","status":"in force (codified in ASC 820)","last_verified":"2026-10-01"}}],"faq":[{"q":"Why does the terminal value make up most of a DCF?","a":"Because it captures all cash flows after the forecast period, which for a going concern is most of its life. That is why terminal growth and discount rate assumptions deserve the most scrutiny."},{"q":"Is DCF used to value private equity portfolio companies?","a":"Mainly as a cross-check. Market multiples are the more common primary technique for equity holdings, while DCF is standard for debt instruments, infrastructure and situations where cash flows are contractual or a sale price is substantially agreed."}],"seo":{},"first_published":null,"last_reviewed":"2026-10-01","last_modified":"2026-10-01","content_version":"2.0.0","url":"https://altss.com/glossary/discounted-cash-flow","json_url":"https://altss.com/reference/concepts/discounted-cash-flow.json","title":"Discounted Cash Flow (DCF)","formulas":[{"formula_id":"F-VAL-013-enterprise-value-from-unlevered-free-cash-flow","concept_id":"ALTSS-VAL-013","label":"Enterprise value from unlevered free cash flow","plain":"EV = Σ FCFF_t / (1 + WACC)^t for t = 1…N, plus TV_N / (1 + WACC)^N","latex":"\\mathrm{EV}_0 = \\sum_{t=1}^{N}\\frac{\\mathrm{FCFF}_t}{(1+\\mathrm{WACC})^{t}} + \\frac{\\mathrm{TV}_N}{(1+\\mathrm{WACC})^{N}}","variables":[{"symbol":"FCFF_t","meaning":"free cash flow to the firm in year t: operating cash flow after tax, capital expenditure and working-capital investment, before interest"},{"symbol":"WACC","meaning":"weighted average cost of capital"},{"symbol":"N","meaning":"last year of the explicit forecast"},{"symbol":"TV_N","meaning":"terminal value at the end of year N"}],"convention_note":"End-of-year discounting shown; a mid-year convention discounts each year's flow by t − 0.5 years. Discounting free cash flow to equity at the cost of equity gives equity value directly; the two routes agree only if assumptions are consistent."},{"formula_id":"F-VAL-013-terminal-value-gordon-growth","concept_id":"ALTSS-VAL-013","label":"Terminal value (Gordon growth)","plain":"TV_N = FCFF_N × (1 + g) / (WACC − g)","latex":"\\mathrm{TV}_N = \\frac{\\mathrm{FCFF}_N\\,(1+g)}{\\mathrm{WACC} - g}","variables":[{"symbol":"g","meaning":"constant long-run growth rate of cash flows after year N; must be below WACC"}],"convention_note":"The alternative is an exit multiple: TV_N = multiple × a year-N metric such as EBITDA. Each method implies a value for the other, which is a useful cross-check."},{"formula_id":"F-VAL-013-weighted-average-cost-of-capital","concept_id":"ALTSS-VAL-013","label":"Weighted average cost of capital","plain":"WACC = E/(D+E) × k_e + D/(D+E) × k_d × (1 − τ)","latex":"\\mathrm{WACC} = \\frac{E}{D+E}\\,k_e + \\frac{D}{D+E}\\,k_d\\,(1-\\tau)","variables":[{"symbol":"E, D","meaning":"market values (or target weights) of equity and debt"},{"symbol":"k_e","meaning":"cost of equity"},{"symbol":"k_d","meaning":"pre-tax cost of debt"},{"symbol":"τ","meaning":"marginal tax rate on interest deductions"}],"convention_note":"Weights should reflect the capital structure a market participant would assume, not necessarily today's. The cost of equity is commonly estimated with an asset-pricing model plus size or company-specific adjustments; practice varies."}],"sources":[{"source_id":"SRC-IPEV-2025","title":"International Private Equity and Venture Capital Valuation Guidelines (2025 edition)","authors":"IPEV Board","publisher":"IPEV","document_type":"standard","url":"https://www.privateequityvaluation.com/Portals/0/Documents/Guidelines/2025%20IPEV%20Valuation%20Guidelines.pdf","year":2025,"publication_date":"Published 11 December 2025; in effect for quarterly reporting periods beginning on or after 1 April 2026; early adoption encouraged","jurisdiction":"intl","status":"Current; supersedes the December 2022 edition","last_verified":"2026-10-01"},{"source_id":"SRC-US-FASB-ASU-2011-04","title":"ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs","publisher":"Financial Accounting Standards Board","document_type":"standard","url":"https://storage.fasb.org/ASU2011-04.pdf","publication_date":"May 2011","jurisdiction":"US","status":"in force (codified in ASC 820)","last_verified":"2026-10-01"}]}