What a DCF is, explained the way an interviewer asks it.

“Walk me through a DCF.” It is one of the most classic technical questions in investment banking and corporate finance interviews.

The most common mistake is answering with a textbook definition. The interviewer does not only want to know what the three letters mean. They want to see whether you understand the logical chain of the valuation.

The thirty-second answer

A DCF values a company by estimating the cash flows it will generate in the future and bringing them back to today with a discount rate consistent with their risk.

That is already an interview answer. Then the questions start.

From EBITDA to free cash flow

The first real test is understanding what you are actually discounting. A standard approximation of unlevered free cash flow starts from EBIT:

UFCF = EBIT × (1 – tax rate) + D&A – Capex – ΔNWC

The point is not memorising the formula. It is understanding why.

• You start from operating profit.
• You pay operating taxes.
• You add back depreciation and amortisation because they are non-cash.
• You subtract capex because it is money actually invested.
• You subtract the increase in net working capital because it absorbs cash.

The result is cash available to all providers of capital, before any decision about debt and interest. Which is exactly why it gets discounted at the WACC.

Why the WACC?

The weighted average cost of capital represents the return required on average by the company’s financiers, combining the cost of equity and the cost of debt according to the capital structure.

The important rule is matching: cash flows and discount rate have to be consistent. If you are valuing cash flows available to both shareholders and creditors, you use a rate that reflects both sources of capital. Hence the WACC in the classic enterprise DCF.

The terminal value

You can explicitly forecast revenue, margins, capex and working capital for five or ten years. Not for seventy.

So you need a terminal value, representing the company beyond the explicit forecast period. One method is perpetuity growth:

TV = FCF(n+1) / (WACC – g)

The other method widely used in practice is the exit multiple, applying for example an EV/EBITDA multiple to a financial metric of the final forecast year.

The terminal value then has to be discounted back to today, exactly like the other cash flows. And this is where the model becomes very sensitive to assumptions: small changes in WACC, terminal growth or the exit multiple can move the valuation significantly.

Enterprise value and equity value

This is another place where candidates trip. If you discounted unlevered free cash flows you get an enterprise value, not the value of the shares.

Equity Value = Enterprise Value – Debt + Cash

In reality there can be further adjustments: minority interests, preferred stock, non-operating investments, pension liabilities and other items. The interviewer mainly wants to see that you do not confuse the value of the operations with the value belonging to shareholders.

How to answer in the room

“I would project the company’s unlevered free cash flows over an explicit forecast period, typically starting from EBIT after tax, adding back non-cash D&A and subtracting capex and changes in working capital. I would discount those cash flows using WACC, calculate terminal value using either a perpetuity growth approach or an exit multiple, discount the terminal value back to present and add everything together to get enterprise value. I would then bridge from enterprise value to equity value by subtracting net debt and making any other relevant adjustments.”

There is no need to rush. What matters is that each step naturally triggers the next one. Practise the answer out loud before the role you are aiming for opens, not after the interview invitation.

The follow-up questions to expect

• If the WACC goes up, all else equal, the DCF value goes down.
• If the terminal growth rate goes up, the value goes up.
• If capex increases without a matching future effect on growth, free cash flow falls and so does the valuation.
• If working capital absorbs more cash, free cash flow falls.

And if the interviewer asks which part of the DCF you would look at most carefully, a good answer is not “the formula”. It is the assumptions: revenue growth, margins, reinvestment, WACC and terminal value.