In plain English
A business is worth the cash it will hand over, adjusted for waiting and for risk. Everything else — multiples, comparables, precedent deals — is a shortcut to that same number.
The advanced view
Intrinsic (DCF) and relative (multiples) valuation must be made consistent: a multiple is a compressed DCF, since P/E ≈ payout/(r − g) and EV/EBIT falls out of the same algebra. The discipline is matching numerator to denominator — equity value with equity flows, enterprise value with unlevered flows — and being explicit about whether growth is funded.
Valuation is where finance becomes applied, and you need all three approaches. DCF: project free cash flows for 5–10 years, calculate a terminal value (usually a growing perpetuity), discount at WACC to get enterprise value, subtract net debt for equity value, divide by shares for value per share. A DCF is only as good as its assumptions, so sensitivity on WACC and terminal growth is mandatory.
DCF structure
EV = Σ [FCF_t / (1+WACC)^t] + TV / (1+WACC)^n TV = FCF_(n+1) / (WACC − g) Equity value = EV − Net debt Price per share = Equity value / Shares outstanding FCF = EBIT×(1−Tc) + D&A − Capex − ΔNWC
Relative valuation compares a company's ratio to peers: P/E, EV/EBITDA, EV/Revenue for high-growth or unprofitable firms, P/B for banks and asset-heavy businesses. EV-based multiples are capital-structure neutral; P/E is not. Precedent transactions look at what acquirers actually paid, including a control premium of typically 20–40%.
Strategy connection
A DCF is a quantified strategic thesis. The growth rate encodes your view on market position, the margin trajectory encodes operating leverage and competitive intensity, and the terminal growth rate encodes the durability of competitive advantage. If you cannot defend these with a strategic argument, your valuation is just arithmetic.
Intuition
A valuation is an argument with numbers attached. The DCF makes the argument explicit; multiples borrow someone else's argument. Because terminal value is usually most of the answer, the assumptions that matter are the long-run ones: growth, margin and reinvestment.
Common pitfalls
- ×Building a five-year forecast in detail while leaving terminal growth unexamined.
- ×Comparing EV/EBITDA across companies with different capital intensity.
- ×Dividing enterprise value by an equity metric, or forgetting net debt in the bridge.
- ×Double-counting synergies in both the cash flows and the multiple.
Worked example — DCF with terminal value
Step 1 of 5
- 1FCF year 5 = 120, WACC 9%, g =
Why it works
The bridge from enterprise to equity value works because claims are ordered: operating assets generate the cash, debt holders are paid first, and equity keeps the residual. Subtract net debt, minorities and other claims, add non-operating assets, and you get what a share is actually entitled to. Terminal value dominates because a perpetuity capitalises everything beyond the forecast — typically 60–80% of the DCF.
How it is used — a 60-second DCF in an interview
Step 1 of 5
- 1FCF next year 50, growing 2% forever, WACC 9%.
Deeper
Deeper: reconciling DCF with multiples
A multiple is a compressed DCF. For a stable business, EV/EBIT ≈ (1 − t)(1 − g/ROIC) ÷ (WACC − g). That formula explains why high-growth, high-ROIC companies deserve higher multiples and why growth with low ROIC adds nothing. Always back out the implied multiple from your DCF and compare it with the peer set: a large gap means your growth or WACC assumption is doing the talking.
Mind the bridge. Enterprise value − net debt − minorities − pensions − preferred + associates = equity value. Multiples must match: EV pairs with EBITDA, EBIT and sales; price pairs with earnings and book value. Pairing P/E with EV/EBITDA in the same sentence without adjusting for leverage is the most common valuation error in interviews.
Must know cold
- ✓Equity value = EV − net debt (plus the other bridge items).
- ✓EV multiples use pre-interest metrics; equity multiples use post-interest metrics.
- ✓DCF value ≈ explicit-period PV + discounted terminal value.
- ✓Cross-check every DCF with an implied multiple and a comparable set.
Exercises
Try each one on paper before revealing the worked solution.
Exercise 1
FCF next year 50, WACC 9%, g 3%, net debt 200, EBITDA 70. Compute EV, equity value and the implied EV/EBITDA. Peers trade at 11×. Comment.
Exercise 2
Why can two companies with identical EV/EBITDA have very different P/E?
Near-term cash flows are barely discounted, far ones heavily. A DCF is therefore mostly a statement about the next few years plus a single terminal assumption; sensitivity tables on WACC and g exist because that last assumption carries the weight.