DCF Enterprise Valuation with FCFF
An enterprise discounted cash flow values the operating business in three steps. Forecast free cash flow to the firm over an explicit planning period, discount each year at the WACC, and add a discounted terminal value for all cash beyond the horizon. The sum is enterprise value. The cash flow here is FCFF, a cash measure built from after-tax operating profit (NOPAT) plus depreciation minus capital spending and working-capital change, deliberately distinct from accounting net income. Because the terminal value often exceeds half of the total, its growth and discount-rate assumptions deserve the closest scrutiny.
Try it yourself
Discount free cash flow to the firm at the WACC, add a terminal value for the years beyond the explicit horizon, and you get enterprise value. Subtract net debt to reach equity value, then divide by shares for the per-share figure. Watch how much of the answer the terminal value alone carries.
In the TV-heavy case the narrow WACC − g_T gap pushes almost the whole value into the terminal value. That fragility is why analysts stress-test g_T.
Cash, not accounting profit:FCFF is cash to all capital providers after reinvestment (roughly EBIT(1 − tax) + D&A − capex − ΔNWC), not net income or EBIT. Earnings accrue revenue and expense before cash actually moves, so a profitable firm can still have weak FCFF.
Reflect: when the terminal value is 80%+ of EV, the valuation rests less on the five years you forecast carefully and more on one perpetual-growth guess. Does a longer explicit horizon genuinely reduce that reliance, or does it just move the same uncertainty further out?
Why it matters
A company is worth the cash it will hand its investors. The enterprise DCF splits that future in two. A finite stretch you can forecast year by year, and everything after, lumped into a single terminal value. You discount both back to today at the WACC, the blended rate for all the firm’s capital. The slides put it bluntly. The terminal value can be more than half of enterprise value, so the part you understand least often weighs the most. That is why a careful analyst stress-tests the terminal assumptions before trusting the headline number.
Formulas
Worked examples
A firm is expected to produce FCFF of US$10m, US$11m and US$12m over three years, then a terminal value of US$180m at the end of year three. The WACC is 9 percent. What is enterprise value, roughly?
Discount each flow at 9 percent. Year one US$10m over 1.09 is about US$9.17m. Year two US$11m over 1.09 squared is about US$9.26m. Year three US$12m over 1.09 cubed is about US$9.27m. The terminal value US$180m over 1.09 cubed is about US$139.0m. Adding the four pieces gives roughly US$166.7m of enterprise value. The terminal value alone, about US$139m, is more than four-fifths of the total, which is exactly why its assumptions dominate the result.
Common mistakes
- ✗You discount FCFF at the cost of equity. FCFF is cash to all investors, so it is discounted at the WACC. Only equity cash flow uses the cost of equity.
- ✗The terminal value is a rounding detail. It commonly exceeds half of enterprise value, so its growth and discount-rate inputs carry the most weight.
- ✗Enterprise DCF gives equity value. It gives enterprise value. The equity bridge then subtracts net debt and other claims.
- ✗A longer explicit forecast always improves accuracy. Beyond the point where a firm reaches steady state, extra forecast years add noise more than insight, and the terminal value should take over.
Revision bullets
- •Three steps: forecast FCFF, discount at WACC, add terminal value
- •The sum of both parts is enterprise value, not equity value
- •FCFF is a cash measure built from NOPAT, not accounting net income
- •Discount FCFF at the WACC because it is cash to all capital
- •The terminal value often exceeds half of enterprise value
- •Stress-test terminal growth and discount rate before trusting the result
Quick check
In an enterprise DCF, free cash flow to the firm is discounted at the
The slides note that in a typical DCF the terminal value usually represents
Connected topics
Sources
- Titman & Martin, Ch. 9Titman, S., & Martin, J. D. Valuation: The Art and Science of Corporate Investment Decisions. Pearson.Lays out the two-step enterprise DCF, forecasting firm cash flows and discounting them at the cost of capital.
- Kaplan & Ruback (1995), JFKaplan, S. N., & Ruback, R. S. "The Valuation of Cash Flow Forecasts: An Empirical Analysis." The Journal of Finance, 50(4), 1995, pp. 1059-1093.Empirical evidence that discounted cash flow valuations are reliably close to observed transaction values.