How to Answer “Walk me through a DCF.” in Investment Banking Interviews
In investment banking interview prep, “Walk me through a DCF” is a staple because it quickly reveals whether you can explain valuation with structure and judgement, not just recite formulas.
A strong walkthrough follows the DCF valuation process end-to-end: build cash flow projections, discount them at WACC, compute terminal value, and bridge from enterprise value to equity value—while calling out the assumptions that drive the range.
What IB Interviewers Evaluate in DCF Interview Questions
In investment banking technical questions, interviewers use a DCF walkthrough to test structured thinking under time pressure. They want to hear a clean sequence (forecast → free cash flow → discount rate → terminal value → equity bridge) and that you understand what the output represents (typically enterprise value first).
They’re also testing modelling judgement: which operating drivers matter most, how you’d pick defensible inputs for WACC and terminal assumptions, and how you handle areas that are usually messy in practice (non-operating items, share count, cyclicality, near-term negative cash flow).
Finally, it’s a communication check. Analysts often need to summarise a model for seniors quickly, so the best answers stay high-signal: identify the key value drivers, mention 1–2 sanity checks, and avoid drowning in line-item detail.
Step-by-step guide to DCF in Investment Banking
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Step 1: Define the DCF output and set the structure
Start with a one-sentence definition: a DCF values a business based on the present value of its future unlevered free cash flows. Then state the structure you’ll follow so the interviewer can track you.
A clear interview version is: choose an explicit forecast period (often 5–10 years), build operating assumptions to create cash flow projections, discount those cash flows at WACC, add a discounted terminal value to capture value beyond the forecast, and then reconcile from enterprise value to equity value.
Two quick clarifiers help you sound precise: (1) unlevered free cash flow is cash available to all capital providers, so the discount rate is WACC, and (2) the DCF is an intrinsic valuation tool, so you’ll sanity-check it against other valuation techniques (like trading comps) rather than treat the output as “the answer.”
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Step 2: Build driver-based operating forecasts and unlevered FCF
Explain that the forecast should be driven by business levers, not just spreadsheet mechanics. At a high level you forecast revenue (volume/price/mix), operating margins, and reinvestment needs (capex and working capital), with assumptions consistent with the company’s competitive position and cycle.
Then walk through how you get to unlevered free cash flow. A common structure is: start with EBIT, apply taxes to get NOPAT, add back non-cash charges like D&A, subtract changes in net working capital, and subtract capex (and include any other recurring operating cash items that are material for the business).
To show real financial modeling interview prep thinking, mention what you’d pressure-test: working capital intensity vs revenue growth, whether capex supports the growth/margin story, and whether margins converge to a credible steady state by the end of the explicit period.
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Step 3: Choose WACC and discount the explicit-period cash flows
Next, describe the discount rate and the matching principle. Because you’re discounting unlevered free cash flow, you use WACC (a blended required return for debt and equity holders).
At interview level, outline WACC components: cost of equity (risk-free rate + levered beta × equity risk premium, plus any relevant size/country adjustments if appropriate) and after-tax cost of debt, weighted by target or market capital structure weights. If pushed, you can add that beta typically comes from a peer set and may be relevered to the company’s target leverage.
Then state the mechanics: discount each year’s unlevered FCF back to present using (1 + WACC)^t and sum them to get the present value of the explicit forecast period. Call out that you’ll later focus sensitivities on WACC because small changes can move value materially.
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Step 4: Estimate terminal value and compute enterprise value
Explain that terminal value captures cash flows beyond the explicit forecast and often drives a large share of the DCF in practice—so it needs to be defensible.
Cover the two standard methods succinctly:
- Perpetuity growth: Terminal Value = FCF_(n+1) / (WACC − g). Emphasise g should be conservative and consistent with a mature steady state.
- Exit multiple: Apply a market-based EV/EBITDA (or EV/EBIT) multiple to a terminal-year metric, anchored to comps and what the business should look like in steady state.
Discount terminal value back to present and add it to the PV of explicit-period cash flows to get enterprise value. Mention one quick check: the implied terminal multiple (or implied g) should be reasonable relative to the sector and the company’s long-run returns and reinvestment needs.
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Step 5: Bridge to equity value and sanity-check the valuation range
Close by converting enterprise value to equity value. Subtract net debt (debt minus cash) and adjust for other non-common claims as relevant: minority interest, preferred equity, pensions, operating leases (depending on treatment), or other non-operating assets/liabilities. Then divide by diluted shares to get implied value per share if needed.
Finish with the “what would you do next” items that come up in dcf interview questions: run sensitivities on WACC and terminal assumptions (g or exit multiple), check implied valuation multiples vs comps/precedents, and confirm the forecast transitions to a credible steady state (margin levels, reinvestment rates, and working-capital behaviour).
If something looks off, say you’d revisit the key drivers and assumptions rather than force the DCF to match a market price—this signals good judgement in the DCF valuation process.
Model answer for “walk me through a DCF” (Analyst)
A DCF values a company based on the present value of its future unlevered free cash flows. In an interview, I’d project an explicit period, discount those cash flows at WACC, add a discounted terminal value, and then bridge from enterprise value to equity value.
I start by building driver-based operating forecasts—revenue growth, margins, and reinvestment needs. From that I calculate unlevered free cash flow: EBIT after tax to get NOPAT, plus non-cash items like D&A, minus the change in net working capital, and minus capex. Those cash flow projections are the core inputs.
Next I choose the discount rate. Because the cash flows are unlevered, I use WACC—cost of equity and after-tax cost of debt weighted by an appropriate market or target capital structure. I discount each year’s free cash flow back to today using (1+WACC)^t and sum them to get the present value of the explicit forecast.
Then I calculate terminal value using either a perpetuity growth method, FCF in year n+1 divided by WACC minus g, or an exit multiple method based on a reasonable EV/EBITDA or EV/EBIT multiple. I discount the terminal value back to present and add it to the explicit-period PV to get enterprise value.
Finally, I go from enterprise value to equity value by subtracting net debt and other claims like minority interest or preferred equity if applicable, and divide by diluted shares for an implied price. I’d sanity-check implied multiples and run sensitivities on WACC and terminal assumptions since those typically drive the valuation range.
- Open with definition + outputs (unlevered FCF → enterprise value) before any formulas.
- Use the matching language explicitly: unlevered FCF discounted at WACC.
- Name the biggest drivers: operating margins/reinvestment, WACC, and terminal value assumptions.
- Include at least one credibility check (implied multiples and a WACC/terminal sensitivity).
- Keep the initial walkthrough to ~2–3 minutes, then expand only where the interviewer probes.
Common traps in the DCF valuation process
- Mixing levered and unlevered concepts (e.g., discounting unlevered cash flows at cost of equity, or using levered cash flow with WACC).
- Treating terminal value as a plug by using an aggressive g or a random exit multiple without a steady-state story or comps anchor.
- Skipping the enterprise-to-equity bridge (net debt and other claims), so the valuation can’t translate into equity value or per-share value.
- Over-explaining every line item instead of focusing on the main drivers and how assumptions connect to the business.
- Forgetting basic sanity checks: implied terminal multiple, implied growth vs WACC, and sensitivities on WACC and terminal assumptions.
- Sounding purely mechanical—no mention of what you would pressure-test in the forecast (margins, working capital, capex intensity).
Follow-ups on WACC, terminal value, and valuation techniques
How do you calculate WACC quickly in an interview?
State the components: cost of equity (risk-free rate + beta × equity risk premium) and after-tax cost of debt, weighted by market or target capital structure weights.
Perpetuity growth vs exit multiple—when do you prefer each for terminal value?
Perpetuity growth is cleaner when you can justify a stable steady state; exit multiple is helpful when the sector is commonly valued on a multiple—either way, sanity-check the implied multiple or implied g.
What are the biggest value drivers in the DCF valuation process?
Typically WACC and terminal value assumptions first, then steady-state margins and reinvestment (capex and working capital) that determine free cash flow levels.
How do you get from enterprise value to equity value?
Equity value equals enterprise value minus net debt, adjusted for other claims like minority interest, preferred equity, and other non-operating items as relevant; then divide by diluted shares for per-share value.
What sanity checks would you run before trusting the output?
Compare implied EV/EBITDA or EV/EBIT to comps, confirm WACC and terminal assumptions are reasonable, and run a sensitivity table on WACC and terminal value inputs.
Financial modeling interview prep drills for DCF walkthroughs
- Practise a tight 2–3 minute version: definition → cash flow projections → WACC → terminal value → enterprise-to-equity bridge → 1 sanity check.
- Drill the “matching principle” out loud until it’s automatic: unlevered FCF discounted at WACC; equity cash flows discounted at cost of equity.
- Prepare a standard sensitivity talk-track: how a 50 bps WACC move or a 0.5x terminal multiple change impacts value directionally.
- Rehearse 2 variants that often appear in investment banking technical questions: (1) near-term negative FCF but improving economics, and (2) cyclical earnings where mid-cycle assumptions matter.
- Use AceTheRound to run timed mock answers to DCF interview questions and get feedback on structure, clarity, and where your assumptions sound weakest.
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