A DCF values a share as the present value of its future free cash flows: ten years of projected growth plus a terminal value, discounted back at your required return.
The output is exquisitely sensitive to inputs — a point of growth or discount rate moves fair value dramatically. Serious users run pessimistic, base and optimistic scenarios rather than trusting one number.
The discount rate must exceed terminal growth for the math to hold, and terminal growth above long-run GDP growth (~2–3%) implies the company eventually becomes the whole economy.
Most of the value usually sits in the terminal figure rather than the projected decade, which is uncomfortable given it rests on a single growth assumption applied forever. Where the terminal value is 70% or more of the total, the model is largely restating that assumption rather than valuing the cash flows in front of it.
The discount rate is doing two jobs at once — compensating for the time value of money and for the risk that the forecast is wrong — and separating them clarifies the exercise. A higher rate is not a substitute for a more honest forecast, though it is frequently used as one.
Free cash flow is also the input most easily got wrong. It is operating cash flow less the capital spending needed to sustain the business, and treating growth capital expenditure as optional inflates it in exactly the companies whose growth the model is projecting.
Frequently asked questions
What is intrinsic value?
An estimate of what a business is worth today: the sum of its expected future free cash flows, each discounted back to present value. Price is what you pay; intrinsic value is what you get.
What discount rate should I use in a DCF?
Your required annual return for bearing the risk — commonly 8–12% for equities. Higher-risk businesses deserve higher rates, which mechanically lowers today's fair value.
Why do DCF results vary so wildly?
The output is extremely sensitive to growth and discount-rate assumptions; a single point of either moves fair value dramatically. Run pessimistic, base and optimistic scenarios rather than trusting one number.