Complete DCF Walkthrough: From Assumptions to Share Price - Free Stock Investing Lesson | StockTutor

You've learned each component of a DCF. Now it's time to put everything together and value a company from scratch. We'll walk through the entire process using NexGen Software, a fictional mid-sized enterprise software company.

Our Mission: Determine whether NexGen's current stock price of $45 per share represents good value. We'll build a complete DCF model and arrive at an intrinsic value range.

Step 1: Understand the Company#

Before building spreadsheets, understand the business:

NexGen Software Profile#

Item	Details
Business	Enterprise resource planning (ERP) software
Revenue Model	70% subscription, 30% services
Customers	Mid-market companies ($50M-$500M revenue)
Competition	SAP, Oracle (large enterprises), Intuit (small business)
Moat	High switching costs, deep customer integrations
Current Stage	Growth phase, investing heavily in market expansion

Recent Financials#

Metric	2024 (Actual)
Revenue	$800M
Gross Margin	72%
Operating Margin	15%
Net Income	$96M
Depreciation	$24M
CapEx	$40M
Working Capital	$80M (10% of revenue)
Shares Outstanding	100M
Current Stock Price	$45
Market Cap	$4.5B
Net Debt	$200M

Step 2: Build Revenue Projections#

Using the approaches from our forecasting lesson:

Historical Growth#

3-year CAGR: 18%
Last year: 15%
Trend: Decelerating as company matures

Market Context#

Enterprise software market growing ~10% annually
NexGen gaining share but facing more competition
TAM for mid-market ERP: ~$15B

Revenue Projection#

Year	Revenue	Growth	Rationale
2024A	$800M	15%	Actual
2025E	$912M	14%	Continued momentum
2026E	$1,021M	12%	Growth deceleration
2027E	$1,113M	9%	Approaching maturity
2028E	$1,191M	7%	Near market growth
2029E	$1,262M	6%	Terminal approach

5-year CAGR: 9.5% (reasonable for maturing software company)

Step 3: Project Margins and Costs#

Operating Margin Build#

As NexGen scales, we expect margin expansion from operating leverage:

Year	Revenue	Gross Margin	R&D %	S&M %	G&A %	Op Margin
2024A	$800M	72%	18%	30%	9%	15.0%
2025E	$912M	73%	17%	28%	8%	20.0%
2026E	$1,021M	74%	16%	26%	7%	25.0%
2027E	$1,113M	74%	15%	24%	7%	28.0%
2028E	$1,191M	75%	15%	23%	6%	31.0%
2029E	$1,262M	75%	14%	22%	6%	33.0%

Key Assumptions:

Gross margin improves slightly (scale in hosting, subscription mix)
R&D declines as % of revenue (existing products generate more revenue)
S&M efficiency improves (brand recognition, customer referrals)
G&A shows operating leverage (fixed corporate costs)

Step 4: Calculate Free Cash Flow#

FCFF Calculation#

Item	2025E	2026E	2027E	2028E	2029E
Revenue	$912M	$1,021M	$1,113M	$1,191M	$1,262M
Operating Income	$182M	$255M	$312M	$369M	$416M
(-) Taxes (25%)	($46M)	($64M)	($78M)	($92M)	($104M)
NOPAT	$137M	$191M	$234M	$277M	$312M
(+) Depreciation	$27M	$31M	$33M	$36M	$38M
(-) CapEx (5% of rev)	($46M)	($51M)	($56M)	($60M)	($63M)
(-) Δ Working Capital	($11M)	($11M)	($9M)	($8M)	($7M)
Free Cash Flow	$107M	$160M	$202M	$245M	$280M

Assumptions:

Tax rate: 25%
Depreciation: ~3% of revenue (software is asset-light)
CapEx: 5% of revenue (includes capitalized software development)
Working capital: 10% of revenue (change = 10% × revenue growth)

Step 5: Calculate WACC#

Cost of Equity (using CAPM)#

Cost of Equity (CAPM)

R_e = R_f + \beta \times ERP

Where

R_e=Cost of Equity

R_f=Risk-Free Rate

β=Beta

ERP=Equity Risk Premium

Component	Value	Source
Risk-Free Rate	4.5%	10-year Treasury yield
Beta	1.1	Industry average for mid-cap software
Equity Risk Premium	5.5%	Historical market premium

Cost of Equity = 4.5% + 1.1 × 5.5% = 10.55%

Cost of Debt#

Cost of Debt (after-tax) = Interest Rate × (1 - Tax Rate)
Cost of Debt = 6% × (1 - 0.25) = 4.5%

WACC Calculation#

Component	Value	Weight	Weighted Cost
Equity	$4.5B (market cap)	95.7%	10.1%
Debt	$200M (net debt)	4.3%	0.2%
WACC		100%	10.3%

We'll use 10% for round numbers (within reasonable range).

Step 6: Calculate Terminal Value#

Using the Perpetuity Growth Method:

Terminal Value (Perpetuity Growth)

TV = \frac{FCF_n \times (1 + g)}{WACC - g}

Where

TV=Terminal Value

FCF_n=Final Year Free Cash Flow

g=Perpetual Growth Rate

WACC=Discount Rate

Component	Value
2029 FCF	$280M
Terminal Growth Rate (g)	3% (nominal GDP)
WACC	10%

Terminal Value = $280M × 1.03 / (0.10 - 0.03)
Terminal Value = $288M / 0.07
Terminal Value = $4,118M

Terminal Value Sensitivity

At 3% terminal growth, TV = $4.1B. At 4% growth, TV = $4.9B. At 2% growth, TV = $3.6B. This 1% change in growth assumption moves value by $500M-$800M. Always run sensitivity analysis!

Step 7: Discount Cash Flows to Present Value#

Now we bring everything back to today's value:

Year	FCF	Discount Factor	Present Value
2025	$107M	1/(1.10)^1 = 0.909	$97M
2026	$160M	1/(1.10)^2 = 0.826	$132M
2027	$202M	1/(1.10)^3 = 0.751	$152M
2028	$245M	1/(1.10)^4 = 0.683	$167M
2029	$280M	1/(1.10)^5 = 0.621	$174M
Terminal	$4,118M	1/(1.10)^5 = 0.621	$2,557M

Sum of Present Values:

PV of Explicit FCFs (2025-2029): $722M
PV of Terminal Value: $2,557M
Enterprise Value: $3,279M

What This Tells Us#

Terminal value represents 78% of total Enterprise Value ($2,557M / $3,279M). This is typical for DCF models—most value comes from the "forever" cash flows after the explicit forecast period.

Step 8: Bridge to Equity Value#

Enterprise Value represents the value to all capital providers. To get equity value (what shareholders own):

Equity Value = Enterprise Value - Net Debt + Non-Operating Assets

Item	Value
Enterprise Value	$3,279M
(-) Net Debt	($200M)
(+) Excess Cash	$0
Equity Value	$3,079M

Intrinsic Value Per Share = Equity Value / Shares Outstanding
Intrinsic Value = $3,079M / 100M shares = $30.79 per share

The Verdict

Our DCF suggests NexGen is worth $31 per share, but it's trading at $45 per share. Based on our assumptions, the stock appears overvalued by ~45%.

Step 10: Sensitivity Analysis#

But our assumptions might be wrong. Let's test different scenarios:

WACC vs. Terminal Growth Rate#

	g = 2%	g = 3%	g = 4%
WACC = 9%	$36	$44	$57
WACC = 10%	$28	$31	$40
WACC = 11%	$23	$26	$31

Revenue Growth Sensitivity#

Scenario	5-Year Revenue CAGR	Share Price
Bear	6%	$24
Base	9.5%	$31
Bull	13%	$42

Operating Margin Sensitivity#

Scenario	Terminal Op Margin	Share Price
Bear	25%	$25
Base	33%	$31
Bull	38%	$38

Interpreting Our Results#

The Range of Values#

From sensitivity analysis, reasonable intrinsic value ranges from $24 to $57 per share:

Bear case: Lower growth, lower margins, higher WACC → $24
Base case: Our primary assumptions → $31
Bull case: Higher growth, margin expansion, lower WACC → $42-57

Investment Decision Framework#

Current Price vs. Intrinsic	Action
Price far below base case	Consider buying
Price near base case	Hold / neutral
Price far above base case	Consider selling
Price within sensitivity range	Depends on your confidence in assumptions

At $45, NexGen trades above even our bull case base ($42) unless you believe in the most optimistic scenario (4% perpetual growth, 9% WACC). This suggests limited margin of safety.

Common DCF Mistakes to Avoid#

1. Terminal Value Dominance#

If terminal value is >90% of enterprise value, your explicit forecasts don't matter much. Either extend the forecast period or question your terminal assumptions.

2. Inconsistent Assumptions#

If you project 3% terminal growth but assume the company reaches 40% market share, those assumptions conflict. Growth slows when you dominate your market.

3. Ignoring Competition#

Our margin expansion assumes NexGen can reach 33% operating margins. But if competitors cut prices, margins could compress. Always consider competitive scenarios.

4. False Precision#

We calculated $30.79. But given the uncertainty, saying "$28-34 range" is more honest than implying three-decimal precision.

5. Forgetting Non-Operating Items#

Some companies have significant non-operating assets (investments, real estate, cash). These add to equity value beyond the DCF of operating cash flows.

Key Takeaways

The 10-Step DCF Process:

Understand the business - competitive position, moat, growth drivers
Project revenue - historical trends, market sizing, growth fade
Project margins - operating leverage, industry benchmarks
Calculate Free Cash Flow - NOPAT + D&A - CapEx - Δ WC
Determine WACC - Cost of Equity (CAPM) and Cost of Debt blended
Calculate Terminal Value - perpetuity or exit multiple
Discount to present - apply discount factors to all cash flows
Bridge to Equity Value - subtract net debt
Calculate share price - divide by shares outstanding
Run sensitivity analysis - test key assumptions

Key Insights:

Terminal value typically represents 60-80% of total value
Small changes in WACC or terminal growth dramatically affect value
Express value as a range, not a precise number
Always ask: "What would make me wrong?"

Try It Yourself: Real DCF Analysis#

Now that you understand the DCF process, put your knowledge into practice with real stocks. Select a company below to see a complete DCF valuation using live financial data.

DCF Valuation Explorer

Interactive

Select a stock to see its DCF valuation. The model uses real financial data to project free cash flows and calculate intrinsic value. Compare the result to the current market price to see if the stock appears undervalued or overvalued.

💡 Try different stocks to see how DCF valuations vary. Compare intrinsic values to market prices and explore how sensitivity to assumptions affects the result.

Complete DCF Walkthrough: From Assumptions to Share Price#