Two-Stage DCF Valuation
Two-stage discounted cash flow: explicit FCF projection for n₁ years at growth rate g₁, then a Gordon-style terminal value at perpetual growth rate g₂. Discounts both stages at WACC (r) to today.
When to use: Use as the canonical fundamental-valuation framework. DCF works for any cash-generative business and is especially powerful for companies in growth-to-maturity transitions where DDM's constant-growth assumption is too restrictive.
Formula
Variables
| Symbol | Name | Description | Unit |
|---|---|---|---|
| DCFValue | DCF Value | Present value of projected cash flows plus terminal value | $ |
| FCF0 | Current FCF | Most recent free cash flow | $ |
| g1 | High-Growth Rate | Growth rate during the high-growth stage, as a decimal | % |
| n1 | High-Growth Years | Years in the high-growth stage | years |
| g2 | Terminal Growth Rate | Growth rate after the high-growth stage, as a decimal | % |
| r | Required Return | Annual required rate of return as a decimal | % |
Real-Life Examples
Example 1: Mid-Cap DCF
Current FCF $400M. High-growth phase: 12% annual growth for 5 years. Terminal growth 3%. WACC 9%.
Given
Step-by-Step
Enterprise value ~$10.0B. Subtract net debt to get equity value, divide by shares for per-share intrinsic value. Sensitivity check by flexing g₁, g₂, and r matters more than any single point estimate.
Frequently Asked Questions
Typically 5-10 years. Beyond 10 years, projections are speculative; under 5 years, the terminal value dominates so heavily that the explicit forecast adds little. Sweet spot: 5-7 years for most businesses, longer for unusually durable franchises.
Because it captures cash flows beyond the explicit horizon — typically 60-80% of total enterprise value. This means terminal-growth and discount-rate assumptions drive the answer more than the explicit forecast does.
Unlevered (FCF to firm, before interest) discounted at WACC gives enterprise value. Levered (FCF to equity, after interest) discounted at cost of equity gives equity value directly. Both methods should reconcile if applied consistently.