Introduction
The Discounted Cash Flow (DCF) model is a cornerstone of corporate finance and investment decision-making. If you’re interviewing for any role in investment banking, private equity, or corporate development, you’ll almost certainly be asked about it. Understanding how to build a DCF model from the ground up—and being able to explain each step clearly—is critical for interview success. In this blog, we break down what a DCF is, when it’s used, and how to construct one that stands up to scrutiny.
A DCF estimates the value of a business by forecasting its future cash flows and discounting them back to present value. It’s used when there’s visibility into a company’s long-term cash generation and is especially useful in scenarios where comparable data is limited or the business has unique cash flow dynamics.
Steps to Build a DCF:
- Forecast Free Cash Flows: Start by projecting revenue growth, operating margins, taxes, changes in working capital, and capital expenditures. This yields free cash flow to the firm (FCFF).
- Calculate the Discount Rate (WACC): The Weighted Average Cost of Capital reflects the cost of both equity and debt, adjusted for risk.
- Determine Terminal Value: Use either the perpetuity growth method or an exit multiple based on comparable companies to estimate the company’s value beyond the projection period.
- Discount Cash Flows to Present Value: Apply the WACC to each year’s projected cash flows and terminal value to calculate the total enterprise value.
Common Mistakes:
- Overestimating growth rates without justification
- Using incorrect or outdated WACC assumptions
- Ignoring the impact of changing working capital or capex
Conclusion
A well-built DCF demonstrates your grasp of valuation fundamentals and your ability to think like an investor. At Circle Square, we don’t just tell you to “learn DCF”—we provide context. We know which clients test it heavily and tailor your prep to reflect real interview scenarios. We even provide past examples and case formats so you can walk into your interview with clarity and confidence.
