DCF Interview Questions

The DCF is the most requested walk-through in banking interviews. These questions cover the full build, from unlevered free cash flow through WACC and terminal value, plus the follow-ups interviewers use to test depth.

13 questions

Advanced questions

Superday-level questions with full model answers.

All practice questions

Walk me through a DCF from start to finish in under two minutes.
  • Why do we use unlevered free cash flow in a standard DCF, and what discount rate must pair with it? What would change if we used levered free cash flow instead?
  • A DCF's output is enterprise value. Walk through every adjustment needed to get from that number to an implied share price.
  • Why does a DCF need a terminal value at all, and what are the two standard ways to calculate it?
  • What are the main weaknesses of a DCF, and for what kinds of companies is it a poor primary methodology? Name at least two company types and explain why for each.
  • Terminal value is typically 60–80% of enterprise value in a DCF. Why is that the case, and what does it imply about how you should present and sanity-check the analysis?
  • How would you value a bank with a DCF? Explain why the standard unlevered approach fails and exactly what you would do instead.
  • A company generates UFCF of $50M in Year 1, $60M in Year 2, and $70M in Year 3, with a terminal value of $900M at the end of Year 3. WACC is 10%. The company has $250M of net debt and 50M fully diluted shares. Calculate the implied share price, showing every discounting step.
  • Your DCF implies $95 per share; the stock trades at $60. Your MD asks you to 'reverse the DCF.' Explain precisely what that means mechanically, then describe how you would isolate whether the gap comes from the market's implied terminal assumptions versus its implied near-term forecasts.
  • You are valuing a company about to undergo an LBO that will take leverage from 1x to 7x EBITDA, deleveraging back to 3x over five years. Why is a single constant-WACC DCF conceptually wrong here, and walk through how APV would handle the valuation instead, including what gets discounted at which rate.
Why is interest expense excluded from unlevered free cash flow, and where in the DCF is the cost of debt (including its tax benefit) actually captured?
  • Define unlevered free cash flow, write out the standard formula from EBIT, and explain in one sentence why each component is added or subtracted.
  • A company's net working capital goes from $80M to $95M during the year. What is the impact on UFCF and why? What would a decrease from $80M to $70M do instead?
  • If depreciation is added back to get UFCF, does a company's D&A level affect its DCF value at all? Explain the mechanism precisely.
  • Walk me from net income to unlevered free cash flow, and explain why the interest add-back must be after-tax rather than the full expense.
  • Your final explicit-forecast year shows revenue growth of 11%, EBIT margin up 150bps year-over-year, and CapEx at 2.2x D&A. What is wrong with applying a Gordon growth terminal value to this year, and how would you fix the model?
  • How should stock-based compensation be treated in unlevered free cash flow? Give the defensible approaches and explain what combination of choices overstates value.
  • Compute UFCF: EBIT $240M, tax rate 26%, D&A $55M, CapEx $70M, NWC rises from $150M to $166M, and deferred tax liabilities increase by $8M. Then state what single number changes if $30M of stock-based comp inside EBIT is added back, and what you must adjust elsewhere to keep the valuation honest.
  • A subscription-software company collects annual contracts upfront, so working capital is deeply negative and becomes more negative as it grows. Walk through how ΔNWC behaves in the forecast, what happens to UFCF if growth suddenly decelerates from 25% to 5%, and why cash flow can deteriorate faster than earnings in that scenario.
  • You're valuing a capex-heavy industrial that just completed a multi-year capacity expansion: last year CapEx was $500M against D&A of $180M, and tax depreciation is accelerated relative to book. Lay out how you would project CapEx, D&A, cash versus book taxes, and deferred taxes over a 7-year explicit period so that the terminal year is internally consistent, and identify which of these items must converge by the terminal year and why.
Explain why beta measures only systematic risk and not total risk. Why is that the economically correct thing for CAPM to price?
  • Write the CAPM formula and define each of its three components in one sentence each.
  • Why is a long-duration government bond yield (e.g., the 10-year Treasury) used as the risk-free rate, rather than a short-term rate?
  • Compute the cost of equity given a risk-free rate of 4.2%, an equity risk premium of 5.0%, and a beta of 1.4.
  • Why can't you directly average the levered betas of several comp companies with different capital structures? What do you do instead?
  • You have two comps: Comp A with levered beta 1.25, D/E of 25%, tax rate 24%; Comp B with levered beta 1.60, D/E of 55%, tax rate 24%. Unlever both betas and compute the average unlevered beta.
  • Using the average unlevered beta from the previous question, relever it to a subject company's target D/E of 45% (tax rate 24%), and compute its cost of equity given Rf of 4.0% and ERP of 5.5%.
  • A comp has a distorted effective tax rate of 6% due to large NOL carryforwards, a levered beta of 1.35, and D/E of 40%. Explain why you should not use its 6% effective tax rate directly in the unlevering formula, what you should use instead, and compute the unlevered beta both ways (using 6% and using a normalized 25% marginal rate) to show the magnitude of the distortion.
  • A subject company currently has D/E of 20% but plans a recapitalization that will bring it to a target D/E of 80% within the year. You've derived an average unlevered beta of 0.95 from a comp set (25% tax rate). Compute the cost of equity using (a) the current D/E of 20% and (b) the target D/E of 80%, given Rf of 4.5% and ERP of 5.5%, and explain which one is appropriate for valuing the company going forward and why.
  • Explain the difference between a historical equity risk premium and an implied (forward-looking) equity risk premium, and describe a market environment in which the two would diverge significantly. If the implied ERP is currently 3.5% but the historical average is 5.5%, and you use the historical figure in your CAPM calculation, what direction of bias does this introduce into your DCF valuation relative to current market pricing?
Explain why the cost of debt is tax-affected but the cost of equity is not.
  • Write out the full WACC formula and define every term. Which two terms represent the market's forward-looking view versus a contractual/historical figure?
  • Why do we use the yield to maturity on a company's debt rather than its coupon rate when estimating the cost of debt?
  • Why should capital structure weights reflect the company's target structure rather than its current balance sheet, and give an example of when the two would diverge.
  • A company has no public debt. Describe, step by step, how you would estimate its cost of debt using the synthetic credit rating approach.
  • Explain the circularity problem that arises if you try to solve for a company's mathematically optimal (WACC-minimizing) capital structure, and how practitioners work around it.
  • A company's EBIT is $120mm and interest expense is $24mm, mapping to a synthetic single-A rating with a 1.2% spread over a 4.0% risk-free rate. Tax rate is 24%. Compute the after-tax cost of debt.
  • A company has market equity of $2,400mm, market debt of $800mm, cost of equity 13%, pre-tax cost of debt 5.5%, and a marginal tax rate of 25%. It also has $1bn of NOLs fully shielding taxable income for the next two years only. Compute WACC for year 1 and for year 3, and explain why they differ.
  • A company just issued $500mm of debt to fund an acquisition, taking D/V from a historical 20% to a current 50%. Peers run at 25% D/V long-run. The company plans to delever back to 25% over four years. Explain, with reference to both Re and Rd, why using today's 50% D/V weight with today's (higher-leverage) beta would be doubly wrong for a DCF used to value the company on a going-concern, steady-state basis.
  • A company's bonds trade at 85 cents on the dollar with a 5% coupon and 4 years to maturity (assume annual coupons, par value $100, for simplicity ignore compounding intricacies and estimate the approximate current yield plus a rough YTM approximation). Explain qualitatively why 5% would be the wrong number to use in WACC and what the price signal tells you about the direction of the error.
Describe the cross-check between the Gordon growth and exit multiple methods. Why is this considered a critical step rather than an optional nicety?
  • What share of total DCF enterprise value does terminal value typically represent, and why does that matter for how you present a DCF's output?
  • Write the Gordon growth terminal value formula and the exit multiple terminal value formula. What does each require to be a valid, sensible calculation?
  • Why must the perpetuity growth rate g be less than WACC? Explain both the mathematical and economic reasons.
  • Terminal-year FCF is $60mm, WACC is 10%, and g is 2.0%. Compute the terminal value as of the terminal year and its present value if the terminal year is year 6.
  • Explain what a 'fade period' is and why a model that jumps directly from a high explicit-period growth rate to a low terminal growth rate without one might be understating or overstating value.
  • A cyclical company's terminal year happens to land at a cyclical peak. Explain the specific error this introduces into an exit-multiple terminal value calculation and how you would correct for it.
  • Terminal-year EBITDA is $220mm and terminal-year FCF is $130mm. WACC is 8.5%. Peers trade at 10x-11x EV/EBITDA. Using Gordon growth with g=3.5%, compute the terminal value and its implied exit multiple. Is the assumption defensible? If not, propose a corrected g and recompute.
  • A company's reinvestment rate (CapEx plus working capital investment as a share of NOPAT) in its explicit forecast period is 40%, supporting 12% annual growth. In the terminal year, the model assumes growth drops to g=2.5% but leaves the reinvestment rate at 40%. Explain precisely why this understates terminal-year free cash flow, and describe how you would correct the reinvestment assumption using the relationship between g, ROIC, and reinvestment rate.
  • You are asked to defend a terminal value where Gordon growth (g=3.0%, WACC=9%) and an exit multiple of 11x on peers trading at 9x both appear in the same model, and they do NOT reconcile: Gordon growth's implied multiple is 13.5x. Walk through, step by step, how you would diagnose which input (WACC, g, or the chosen exit multiple) is most likely the source of the inconsistency, and how you'd defend your final choice to an MD who wants a single terminal value in the model.
Why does cash flow actually arrive throughout the year rather than as a lump sum, and how does mid-year convention approximate that reality?
  • Write the standard end-of-year discounting formula and the mid-year convention version. What single change distinguishes them?
  • Does mid-year convention increase or decrease enterprise value relative to end-of-year discounting, and roughly by how much for a typical WACC?
  • A cash flow of $40mm is expected in year 4. WACC is 8%. Compute its present value under both end-of-year and mid-year convention.
  • Derive, algebraically, the exact percentage uplift that mid-year convention produces relative to end-of-year discounting, as a function of WACC alone.
  • Explain what a stub period is and why it requires both a prorated cash flow and a different discount exponent than a full year would.
  • You are valuing a company on October 1st with a December 31st fiscal year-end. The current fiscal year's full-year FCF is projected at $200mm and next fiscal year's is $220mm. Compute the stub-period FCF and its discount exponent, and the following full year's discount exponent, assuming mid-year convention and ratable cash generation.
  • Explain the theoretical argument for NOT applying mid-year convention to an exit-multiple-based terminal value, even while applying it to the explicit forecast period. What kind of business event does the exit multiple represent that makes this argument coherent?
  • A DCF has explicit-period PV of cash flows of $500mm and an unadjusted (end-of-year, full n=6) terminal value PV of $2,100mm at WACC 9%. Recompute the terminal value's PV under mid-year convention (n − 0.5 = 5.5) and quantify the total enterprise value difference in dollars and percent versus the end-of-year figure.
  • A ski resort's cash flows are heavily concentrated in Q4 and Q1 (winter season), with almost no cash generated in Q2-Q3. Explain specifically why the standard mid-year convention is a poor approximation for this business, and describe the more rigorous alternative you would build instead.
Explain why an LBO ability-to-pay analysis typically forms the floor of a football field. What two constraints cap the sponsor's price?
  • Why do bankers present valuation as a football field of ranges rather than a single number? What does each of the standard bars contribute?
  • Which two variables would you sensitize in a DCF using Gordon growth terminal value, and why those two specifically?
  • Why do precedent transaction bars usually sit above trading comps bars on a football field? Give both economic reasons.
  • Your DCF sensitivity grid includes a cell with WACC of 6.5% and terminal growth of 6.5%. What does that cell produce mathematically, and why is it economically meaningless?
  • Terminal-year FCF is $90mm, WACC is 10%, terminal growth is 2%. Terminal-year EBITDA is $140mm. Compute the terminal value and the implied exit multiple, and state whether it is defensible if comps trade at 8x–9x.
  • A company's 52-week range is $30–45, comps imply $38–46, precedents imply $50–58, the DCF gives $42–56, and an LBO supports up to $48. The board asks whether to accept an all-cash bid at $52. Using the field, structure your recommendation and identify what additional work you would show.
  • Net debt is $400mm and diluted shares are 60mm. Trading comps of 9.0x–10.5x apply to forward EBITDA of $180mm. Compute the implied per-share range, then recompute if you discover $50mm of the 'cash' netted in net debt is trapped overseas and should be excluded. Quantify the per-share impact.
  • A sponsor exits in year 5 at 9.0x EBITDA of $260mm with $700mm of net debt remaining at exit, and requires a 2.5x MoIC. Lenders will fund entry leverage of 5.5x on entry EBITDA of $200mm. Solve for the maximum enterprise value the sponsor can pay today and express it as an entry multiple. Show all steps.
  • Your Gordon growth terminal value (WACC 8.5%, g 3.0%) implies a year-5 exit multiple of 14x EBITDA while comps trade at 10x today. The MD asks you to defend or fix the model in front of the client tomorrow. Walk through the full reconciliation: what is inconsistent, the two levers you could move, the cross-check math you would run after each change, and how you would present the corrected sensitivity range.