Discounted Cash Flow (DCF) Valuation

When it comes to valuing a startup, there are multiple methodologies out there—each with its own logic and application. Among them, Discounted Cash Flow (DCF) analysis stands as one of the most robust and widely accepted methods. It’s a fundamental tool in corporate finance, used by investors, analysts, and founders to estimate the value of a business based on its future cash flow potential.
What is Discounted Cash Flow (DCF) Analysis?

DCF analysis is a valuation method that estimates the present value of a business based on the expected future cash flows it will generate. The key idea is simple: a dollar earned in the future is worth less than a dollar today due to inflation, risk, and the opportunity cost of capital. DCF calculates today’s value of those future earnings by applying a discount rate that reflects these factors.

Here’s how it works in a nutshell:

Forecast future cash flows (usually for 5-7 years).

Determine a terminal value at the end of the forecast period.

Discount all cash flows (including terminal value) to present value using the Weighted Average Cost of Capital (WACC) or a similar rate.

Sum the present values to estimate the enterprise value of the business.

Key Inputs for DCF Valuation

To perform a proper DCF analysis, you’ll need:

WACC: Weighted Average Cost of Capital, can be taken from the Internet, or can be estimated by taking inflation rate, interest rates, risk-free premiums, government bond rates, etc. into account.

Perpetual Growth Rate (Not used if Terminal Value Multiplier is chosen): Estimation of the company's growth rate in perpetuity (theoretical). Cannot be greater than WACC, since it results in "gain with zero risk", an impossible situation in economics. For most DCF analyses, generally 2.5% to 3% is used.

Terminal Value Multiplier (Not used if Perpetual Growth Rate is chosen): Depending on the sector or industry, a decent number between 4 and 10 is generally used. It can be somewhat similar to P/E ratio of current companies in the same sector.

Use PGR or TVM: Both are used in DCF analyses. A good practice is to try both and see whether they produce similar results. If not, consider changing either PGR or TVM.

Currency: As long as all units are consistent, it does not affect the valuation; but share price is calculated according to this unit.

Assets: Can be calculated by summing cash, cash equivalents, inventory, etc.

Liabilities: Can be calculated by summing long term and short term debts, loans etc.

Yearly Net Cash Flows: Can be calculated by substracting all expenses (operational, capital, recurring & non-recurring) from revenues.

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