Case 38 / 183 Entry

Simple DCF: Three Steps

Valuation & DCF

The prompt

“As a financial analyst, you're asked in an interview: "Strip a DCF down to its purest form — no Terminal Value, no complicated build-up. Just three steps: project the cash flow, discount it, and sum it." Walk through how you'd answer that question, using a small company's three-year free cash flow forecast to show how discounting and summing alone produce an Enterprise Value.”

📋 What you're given

As a financial analyst, you're asked in an interview: "Strip a DCF down to its purest form — no Terminal Value, no complicated build-up. Just three steps: project the cash flow, discount it, and sum it." Walk through how you'd answer that question, using a small company's three-year free cash flow forecast to show how discounting and summing alone produce an Enterprise Value.

1. Task Overview

Task: explain how a multi-year cash flow forecast collapses into a single Enterprise Value through discounting and summation alone, using a bare-bones 3-year forecast with no Terminal Value.

Step 1: Given Data — 3-Year Free Cash Flow Forecast

You are given the following free cash flow forecast and discount rate for a small company.

Line ItemValue
Year 1 Free Cash Flow$20.0m
Year 2 Free Cash Flow$22.0m
Year 3 Free Cash Flow$24.0m
Discount Rate (WACC)10.0% (0.10)

Step 2: Present Value of Each Year's Free Cash Flow

Show Present Value Formula

PV = FCF / (1 + r)^n

Using this formula, compute the present value of each year's free cash flow.

Step 3: Enterprise Value (Sum of the Present Values)

Show Enterprise Value Formula

EV = PV(Year 1) + PV(Year 2) + PV(Year 3)

Using this formula, sum the three present values to arrive at Enterprise Value.

💡 Model answer

Try answering out loud first — then reveal the model answer and compare.

⚠️ Common mistakes

  • Summing the raw (undiscounted) free cash flows instead of their present values, which overstates Enterprise Value by ignoring the time value of money
  • Using the wrong exponent for the discount factor — Year 2's cash flow must be discounted by (1 + r)^2, not (1 + r)^1
  • Forgetting that this simple sum produces Enterprise Value, not Equity Value — a net debt/cash adjustment is still needed to bridge to Equity Value
  • Assuming a short explicit forecast alone is a complete DCF — in real models, cash flows beyond the explicit period need a Terminal Value, or the valuation understates the business
  • Discounting every year by the same single-period factor instead of compounding the discount rate for each additional year

🔁 Follow-up questions

➡️ Related cases

Previous Case 37: Terminal Value: Gordon Growth Next Case 39: Full DCF from Scratch

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