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.
What you will learn
- 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
The formulas
- 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
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.
Common 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.