What is DCF valuation

Discounted Cash Flow Method (DCF)

With this method, the future earnings value of the company is estimated on the basis of the free cash flow after taxes.

Nowadays the value of a company is often assessed using the discounted cash flow (DCF) calculation. The DCF method is not (or not only) based on past income, but is primarily intended to determine which income an investor can expect in the future. The basis is the estimated future free cash flow after taxes, because a company is ultimately only worth as much as it can bring in in the future.

The future cash flow is discounted. This gives the present value of the cash flow. The capitalization rate for discounting (discounting) is calculated in the same way as the practitioner method and is usually between 10 and 20 percent.

Depending on the profit expectations, the DCF method can result in unrealistically high company values ​​that cannot be realized on the market. It is therefore almost only suitable for existing companies that have been generating steadily growing profits for years.

The DCF method step by step

  1. Prepare a detailed budget for the years to come. Since investments in current and fixed assets have a significant impact on cash flows, a planning period should be selected that covers an entire investment cycle.
  2. Since the future free cash flows (FCF) can only be reasonably estimated for a certain number of planning years, a so-called residual value (capitalized future pension) is calculated instead of the individual FCF beyond the planning period. This residual value, which usually makes up 50% of the estimated company value, is determined by capitalizing a representative FCF.
  3. Each individual result is then discounted to the valuation date using the weighted cost of capital. All future income is calculated back to the valuation point in order to determine the current value of this income.
  4. The borrowed capital is then deducted from the discounted present values ​​and the assets not required for operations are added. This gives the effective value of the equity (or the share value).