DCF Interview Questions: The Complete List

Forecast unlevered free cash flow (FCFF) for an explicit period, typically 5 to 10 years. Build the discount rate (WACC) from the cost of equity (via CAPM) and after-tax cost of debt, weighted by target capital structure. Calculate terminal value using either the perpetuity growth or exit multiple method. Discount every explicit-period cash flow and the terminal value back to the present at WACC and sum them to get enterprise value. Bridge to equity value by deducting net debt, minority interests, and preferred stock, and dividing by diluted shares to get value per share.

Revenue growth and margin assumptions (which drive free cash flow), the discount rate (WACC or cost of equity), the terminal value method and its growth rate or exit multiple assumption, and the length and granularity of the explicit forecast period.

From a buyer's perspective, a lower discount rate produces a higher valuation, so the "correct" rate should be derived independently from the asset's actual risk, not chosen to produce a preferred outcome. The point of the question is to test whether a candidate understands that a small change in discount rate produces a large change in value, particularly through its effect on terminal value.

A pure DCF is difficult to apply reliably to a pre-revenue company because near-term free cash flow forecasts are largely speculative and terminal value dominates almost entirely. Practitioners typically supplement or replace DCF with comparable transaction multiples specific to the company's stage and sector, scenario-weighted outcomes, or venture-capital-style methods, while still using DCF logic conceptually once a credible cash flow path exists.

Because DCF derives value independently from the company's own forecast cash flows and discount rate, while the trading price reflects the market's collective, possibly different, view of those same inputs, or reflects factors a pure DCF does not capture (short-term sentiment, technical trading factors, control premium considerations). A large divergence is often the basis of an investment thesis rather than evidence that one figure is simply wrong.

Value decreases, and the effect is non-linear — larger for cash flows further in the future, and especially large for terminal value, since terminal value is calculated by dividing by (WACC − g), and a higher WACC narrows that denominator's gap to g.

Value increases, again non-linearly, since a higher g narrows the (WACC − g) denominator in the perpetuity growth formula, disproportionately increasing terminal value.

Net income includes non-cash charges (depreciation, amortization) and does not reflect capital expenditure or working capital investment, both of which are real cash effects that a valuation must capture. Free cash flow adjusts for exactly these items to reflect actual cash generation.

Depreciation is a non-cash accounting charge — no cash actually leaves the business in the current period on account of depreciation — so it is added back to convert accounting profit into cash. Capital expenditure is a real cash outflow in the period it occurs (even though it is capitalized and depreciated over time for accounting purposes), so it is deducted to reflect the actual cash used.

The same mechanical structure applies, but beta must be estimated from comparable listed companies (unlevered and relevered at the private company's target capital structure), and capital structure weights use the target structure rather than an observable market value, since neither is directly quoted for a private company.

Terminal Value = FCF × (1 + g) / (WACC − g), and the constraint is g < WACC, since the formula produces an undefined or negative result if g equals or exceeds WACC.

Apply an observed market multiple (commonly EV/EBITDA) from trading comparables or precedent transactions to the terminal year's corresponding financial metric.

FCFF is unlevered — available to all capital providers before financing effects — and is discounted at WACC to produce enterprise value. FCFE is levered — available to equity holders after debt service — and is discounted at cost of equity to produce equity value directly. FCFE is preferred when capital structure is itself a key variable, such as in an LBO.

Because no business can outgrow the broader economy indefinitely without eventually becoming implausibly larger than the entire economy over a sufficiently long horizon. Convention caps the perpetuity growth rate at or near long-run GDP or inflation expectations for exactly this reason.

Cross-check the implied exit multiple from the perpetuity growth terminal value against observed trading multiples for comparable companies, triangulate the DCF conclusion against relative valuation (comps) and precedent transactions, and confirm terminal value's share of total enterprise value is disclosed and reasonable.

DCF (intrinsic, derived from the company's own forecast cash flows), relative valuation (market-based, derived from comparable company multiples), and precedent transactions (market-based, derived from past M&A deal multiples). Institutional practice triangulates across all three rather than relying on any single method.

Standard unlevered DCF (FCFF/WACC) generally does not work well for banks, since debt is a raw material of banking operations rather than a financing choice separable from operations, and defining free cash flow and capital expenditure in the industrial sense does not translate cleanly. Banks are more commonly valued using a dividend discount model or an excess-return/residual-income framework, applied to equity cash flows directly.

Levered (FCFE) is generally preferred in an LBO context because the debt paydown schedule, driven by the specific acquisition financing structure, is a central value driver that an FCFE build captures explicitly, whereas an FCFF/WACC approach would obscure that effect within a blended, relatively static discount rate assumption.

Terminal value, typically 60 to 80% or more of total value. The risk is that a valuation can appear rigorously derived from a detailed explicit forecast while the majority of its conclusion actually rests on a single growth rate or exit multiple assumption applied at the end of that forecast — a concentration that deserves proportionate scrutiny, not less than the explicit period receives.