How to Walk Through a DCF in an Interview

"Walk me through a DCF" shows up in nearly every investment banking technical interview, from first-round phone screens through final-round superdays. Interviewers ask it because it tests several skills at once: whether you understand what drives a company's intrinsic value, whether you can hold a multi-step process in your head under pressure, and whether you can explain a technical concept clearly out loud. A candidate who can walk through the framework cleanly, then handle the follow-ups on terminal value and WACC, signals real preparation. A candidate who fumbles the order of steps or can't explain why WACC matters signals the opposite.

The Five-Step DCF Framework

A discounted cash flow analysis estimates what a company is worth today based on the cash it's expected to generate in the future. The process breaks into five steps, and interviewers expect you to walk through them in order.

Step 1: Project Unlevered Free Cash Flow

Build a forecast of the company's unlevered free cash flow, typically for five to ten years. Unlevered free cash flow is the cash available to all capital providers, debt and equity holders alike, before financing decisions are factored in. Starting from EBIT, the calculation subtracts taxes, adds back depreciation and amortization, and subtracts capital expenditures and the change in net working capital.

Step 2: Determine the Discount Rate (WACC)

Because unlevered free cash flow belongs to both debt and equity holders, it gets discounted at the weighted average cost of capital, not just the cost of equity. WACC blends the cost of equity and the after-tax cost of debt, weighted by their proportion of the company's capital structure.

Step 3: Calculate Terminal Value

The explicit forecast period only covers five to ten years, but the company will keep generating cash well beyond that. Terminal value captures everything after the forecast period in a single number, using either the perpetuity growth method or the exit multiple method.

Step 4: Discount Everything to Present Value

Discount each year of projected free cash flow, along with the terminal value, back to today using the WACC from step two. Summing those discounted values gives you the company's enterprise value.

Step 5: Bridge to Equity Value and Share Price

Enterprise value reflects the whole company, debt and equity together, so the last step subtracts net debt (and other claims like preferred stock or minority interest) to arrive at equity value. Dividing equity value by diluted shares outstanding gives an implied share price you can compare against where the stock actually trades.

A Worked Example

Say you're valuing a company with the following unlevered free cash flow projections over the next five years: $80M, $88M, $95M, $102M, $108M. The company's WACC is 9%, and you're using a perpetuity growth rate of 2.5% to calculate terminal value.

Terminal value: take year 5's free cash flow, grow it one more year at 2.5% to $110.7M, then divide by (WACC minus growth rate). $110.7M divided by 6.5% gives a terminal value of roughly $1.70B.

Discount each cash flow, and the terminal value, back to present value at 9%:

• Year 1: $80M / 1.09 = $73.4M
• Year 2: $88M / 1.09² = $74.1M
• Year 3: $95M / 1.09³ = $73.4M
• Year 4: $102M / 1.09⁴ = $72.3M
• Year 5: $108M / 1.09⁵ = $70.2M
• Terminal value: $1.70B / 1.09⁵ = $1.10B

Summing all six numbers gives an enterprise value of roughly $1.46B. From there, subtract net debt, say the company carries $200M of net debt, to get an equity value of about $1.26B. Divide by 50M diluted shares outstanding and you get an implied share price of roughly $25.20.

Perpetuity Growth vs. Exit Multiple: Which Terminal Value Method to Use

Interviewers like to ask which terminal value method you'd choose and why. The perpetuity growth method assumes the company grows at a stable, modest rate forever, usually somewhere close to long-run GDP growth, and it ties terminal value directly to the WACC and growth assumptions already in your model. The exit multiple method instead applies a market-based multiple, like EV/EBITDA, to the company's final projected year, anchoring the terminal value to how similar companies actually trade.

Neither method is strictly better. The perpetuity growth method is more defensible in a pure academic sense because it doesn't rely on outside market pricing, but the exit multiple method is easier to sanity-check against real comparable companies. A common move in practice, and a good answer if asked, is to calculate terminal value both ways and use the exit multiple method as a cross-check on the perpetuity growth result.

How to Explain WACC When Asked to Break It Down

If the interviewer pushes past "it's the weighted average cost of capital" and asks you to actually build it, walk through the two components separately.

Cost of equity comes from the Capital Asset Pricing Model: the risk-free rate, plus the company's beta multiplied by the equity risk premium. Beta measures how much the stock moves relative to the overall market, so a beta above 1.0 means the stock is more volatile than the market and demands a higher return.

After-tax cost of debt starts with the company's current cost of borrowing, based on its outstanding debt or credit rating, and then multiplies by (1 minus the tax rate), since interest payments are tax-deductible.

WACC weights these two by the company's target capital structure, the proportion of debt versus equity in how it's financed, not the historical mix from a prior year.

Common Follow-Ups and Pitfalls

"How sensitive is your valuation to the terminal value assumption?" Very. Terminal value often makes up 70% to 80% of total enterprise value in a DCF, since it captures everything beyond the explicit forecast period. Knowing this ratio, and being able to say it out loud, shows the interviewer you understand where the real uncertainty in a DCF lives.

"What's wrong with a DCF?" A DCF is only as good as its assumptions, and small changes to WACC or the terminal growth rate can swing the output significantly. It's also a poor fit for early-stage or highly cyclical companies whose cash flows are hard to project with any confidence.

"Walk me through it faster." Most interviewers expect a 60 to 90 second version of the five-step framework before they ask you to go deeper on any one piece. Practice compressing the walkthrough down to its essentials so you're not still on step two when they want to move on.

Practicing the Full Walkthrough

The DCF question rewards the same kind of repetition as the LBO and three-statement questions: know the five steps cold, be ready to build out WACC or terminal value in more depth on request, and practice saying the whole thing out loud until it doesn't sound like you're reading off a memorized script.