A valuation method that estimates a company's value by discounting its expected future free cash flows to present value, using a rate that reflects the investment's risk.
When an investor wants to know what a company is truly worth — not what the seller is asking or what the market suggests — they turn to the DCF. It is the valuation method that answers the fundamental question: how much cash will this business generate in the future, and what is that worth today?
DCF stands for Discounted Cash Flow. It is an intrinsic valuation method that estimates a company’s value by summing all expected future free cash flows, discounted to present value using a rate that reflects the risk and opportunity cost of the investment.
The premise is simple: a euro today is worth more than a euro tomorrow. The DCF translates that intuition into a financial model that allows comparison of the present value of cash flows occurring at different points in the future.
A DCF has three essential components:
The company’s free cash flows (Free Cash Flow to Firm, FCFF) are projected for an explicit period of 5 to 10 years. Free cash flow is the money the business generates after covering all operating costs, taxes, capital expenditure (capex), and working capital requirements.
The simplified formula is:
FCFF = EBITDA - Operating taxes - Maintenance capex - Change in working capital
The most widely used discount rate is the WACC (Weighted Average Cost of Capital), which weights the cost of debt and the cost of equity according to the company’s capital structure. The higher the perceived business risk, the higher the discount rate and the lower the resulting value.
Since cash flows cannot be projected indefinitely with precision, a terminal value is calculated representing the value of all flows beyond the last projected year. There are two common methods:
The DCF is the backbone of business valuation in the mid-market. While valuation multiples offer a quick reference based on comparable transactions, the DCF enables a customised analysis that captures each company’s unique characteristics: its growth, profitability, investment needs, and risk profile.
In Blue Mountain’s practice, the DCF is used as a cross-check tool: a proprietary model is built, results are contrasted against market multiples, and convergence is sought. If the DCF yields a value very different from multiples, it signals that assumptions need revisiting or that the market may be over/undervalued.
The main risk of the DCF is its sensitivity to input assumptions. Small variations in the discount rate or the perpetuity growth rate generate significant changes in the final value. A sensitivity analysis is essential to bound the valuation range.
The most important limitations are:
A technology services company in Madrid has 12 million euros in revenue and a normalised EBITDA of 2.4 million. An investor builds a DCF with the following assumptions:
The model yields an Enterprise Value of 22.5 million. Adjusting for net debt, the Equity Value comes to 19.8 million. The sensitivity analysis (WACC between 9% and 13%, multiple between 6x and 8x) produces a range of 16 to 24 million.
It is the most conceptually rigorous because it is based on the company’s actual ability to generate cash. However, it is highly sensitive to model assumptions. That is why in M&A it is always used alongside valuation multiples as a cross-reference, never as a standalone method.
The most common rate is the WACC. In the Spanish mid-market, rates between 9% and 14% are typical, depending on the sector and risk profile. Technology companies with high revenue recurrence may sit at the lower end; cyclical industrial businesses at the upper end.
The standard practice is to project 5 to 10 years of explicit cash flows. The terminal value captures perpetual flows beyond that point and typically represents the largest portion of the model’s total value, making it the most sensitive variable.
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