Meaning and transaction use
Damodaran defines DCF value as the present value of expected cash flows, discounted at a rate that reflects their risk. [S1]
Damodaran distinguishes firm valuation, which discounts cash flows to all capital providers at the cost of capital, from equity valuation, which discounts cash flows to equity at the cost of equity. [S1]
IAS 36 uses discounted expected future cash flows to measure value in use and requires an appropriate discount rate, providing an accounting application of present-value principles. [S2]
Worked example
Illustrative enterprise-value DCF only. Assume FCFF of 4.0, 4.5, 5.0, 5.5 and 6.0 million in years one to five, WACC of 10.0%, perpetual growth of 3.0%, debt of 20.0 million, cash of 3.0 million and 10.0 million shares.
Scroll the table horizontally to view all columns.
| Measure | Calculation | Result |
|---|---|---|
| PV of explicit FCFF | 4.0/1.10 + 4.5/1.10^2 + 5.0/1.10^3 + 5.5/1.10^4 + 6.0/1.10^5 | 18.6m |
| Terminal value at year five | 6.0 x 1.03 / (10.0% - 3.0%) | 88.3m |
| PV of terminal value | 88.3 / 1.10^5 | 54.8m |
| Enterprise value | 18.6 + 54.8 | 73.4m |
| Illustrative equity value | 73.4 + 3.0 cash - 20.0 debt | 56.4m |
| Illustrative value per share | 56.4 / 10.0 | 5.64 |
The illustrative enterprise value is 73.4 million and the simplified equity value is 56.4 million, or 5.64 per share. The result depends on the forecast, terminal assumptions, discount rate and full enterprise-to-equity bridge; it is not an offer price or fairness opinion.
Proposed transaction review process
Define the valuation object
Choose enterprise value or equity value, the valuation date, currency, perimeter and cash-flow definition.
Build the operating forecast
Model revenue, margins, tax, investment and working capital from supportable operating drivers.
Set discount and terminal assumptions
Match the rate to the cash flows and document capital structure, risk inputs, terminal growth or exit assumptions.
Bridge, sensitise and reconcile
Convert to equity value, test key inputs and compare the result with market, transaction and balance-sheet evidence.
Evidence checklist
Historical financials
Audited accounts, management accounts, cash-flow conversion and normalisation support.
Operating forecast
Volume, price, margin, tax, working-capital and capital-expenditure assumptions with owners and evidence dates.
Discount rate
Risk-free rate, market risk premium, beta or asset risk, borrowing cost, tax rate and target capital structure.
Valuation bridge
Debt, cash, leases, pensions, minorities, associates, provisions, options and other claims or non-operating assets.
Decision framework
| Situation | Proposed action |
|---|---|
| Cash-flow definitions do not match the rate | Rebuild the valuation on a consistent firm or equity basis before relying on the result. |
| Terminal value dominates the result | Expand the forecast, test convergence and disclose sensitivity to growth and discount rates. |
| Forecast support is weak | Use scenarios, ranges and explicit evidence gaps rather than a single unsupported point estimate. |
| The equity bridge is incomplete | Keep the conclusion provisional until material claims and non-operating assets are reconciled. |
Common errors to check
- Discounting equity cash flows at WACC or firm cash flows at the cost of equity.
- Using a perpetual growth rate equal to or above the discount rate.
- Treating accounting profit as cash flow without investment and working-capital adjustments.
- Presenting a precise output without sensitivity, bridge reconciliation or source dates.
Review the DCF value bridge
Bring the operating forecast, cash-flow definition, discount-rate support, terminal assumptions and enterprise-to-equity bridge to a valuation review. Test the value drivers and unresolved evidence before using the output in a transaction decision.
Discuss the transactionPrimary references and editorial scope
- Aswath Damodaran, An Introduction to Valuation
DCF definition, risk-adjusted discounting and the distinction between firm and equity valuation. Reference checked 17 September 2026. - IFRS Foundation, IAS 36 Impairment of Assets
Discounted expected cash flows and appropriate discount rates in value-in-use measurement. Reference checked 17 September 2026.
General valuation education. Figures are hypothetical and exclude several possible enterprise-to-equity adjustments. A transaction valuation requires company-specific diligence, consistent model definitions, current market inputs and the appropriate accounting, tax, legal and regulatory analysis.
General business information. Obtain advice appropriate to the legal, tax, accounting and financing facts. No offer, lender commitment or transaction outcome is represented. All worked examples use expressly assumed figures. Editorial draft date: 17 September 2026.
