Interviewer: Walk me through a Discounted Cash Flow Model
This is one of the most asked technical questions during investment banking interviews. A DCF model is something you need to know inside-and-out! Missing one question like this can be the difference of getting the offer or not.
So how does a discounted cash flow model work? There are three essential parts to a DCF:
- Company’s Free Cash Flow
- Terminal Value of the Company
- The Weighted Average Cost of Capital (WACC)
Now let’s break these down:
- Free Cash Flow = Operating Cash Flow – Capital Expenditures – Change in Net Working Capital
- Terminal Value of the Company – two methods: EBITDA Multiple or Perpetuity Growth
- WACC – two components: Cost of Equity (CAPM) and the after tax cost of debt
Final Step: Discount all back to find your Enterprise Value (EV) of the Company
Now, this is just a quick-and-dirty version. Street of Walls goes into pages of detail in the Investment Banking Technical Guide.
For those of you looking to really get an edge during interview, go through our Discounted Cash Flow Model that is posted online. This is a fully working investment banking DCF model. A DCF model snapshot taken from the model is shown below:
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