DCF: turning future cash into value today
A beginner-friendly guide to why DCF matters, how the formula works, a simple cafe example, its strengths and limits, and Scroogenie's approach to industry assumptions and negative FCF.
A stock price tells us what a company costs today. To decide whether that price is attractive, however, we need to estimate how much value the business can create.
DCF converts the cash a company may generate in the future into today's value. Its central question is simple.
What would all of this company's future cash be worth if we received it today?
DCF: a foundation of valuation
DCF stands for Discounted Cash Flow. It estimates future cash generation and discounts it for time and uncertainty.
- A business is ultimately worth the cash it can produce.
- One million won in the future is worth less than one million won today.
This article uses FCF throughout to match the term shown in the service. Traditional enterprise DCF may distinguish the same cash flow more precisely as FCFF, or free cash flow to the firm.
Why use DCF?
Relative metrics such as P/E and P/B are useful for quick comparisons, but they can mislead when peers are expensive or companies differ in growth, debt and investment needs.
DCF begins with the cash generated by the company itself. It helps us ask how much growth is priced in, whether earnings turn into cash and whether the current price leaves room for uncertainty.
DCF is not a machine for producing the right answer. It is a way to reveal the expectations embedded in a price.
The DCF formula
- FCFₜ: expected free cash flow in year t
- WACC: a discount rate reflecting the cost of debt and equity
- n: the explicit forecast period
- Terminal value: value generated after the explicit forecast period
A simple example
Assume a small cafe is expected to generate the following FCF over five years. Figures are in KRW millions and the discount rate is 10%.
| Year | Expected FCF | Present value |
|---|---|---|
| 1 | 100 | 90.9 |
| 2 | 110 | 90.9 |
| 3 | 120 | 90.2 |
| 4 | 130 | 88.8 |
| 5 | 140 | 86.9 |
| Total | 600 | 447.7 |
The cafe generates KRW 600 million in nominal cash flow, but only KRW 447.7 million in present value. Assuming 2% perpetual growth, the discounted terminal value is KRW 1,108.3 million and enterprise value becomes KRW 1,556 million.
With KRW 200 million in net debt and 100,000 diluted shares, equity value is KRW 1,356 million, or about KRW 13,560 per share.
This is not a single correct answer. Small changes in the discount rate and perpetual growth rate can move the result substantially, so DCF is more useful as a range of scenarios.
Strengths and limitations
Strengths
- It focuses on the company's actual cash-generating ability.
- It makes assumptions about growth, investment and risk visible.
- It supports conservative, base and optimistic scenarios.
Limitations
- Small assumption changes can produce large valuation changes.
- Long-term cash flows are inherently difficult to forecast.
- Terminal value can dominate the final estimate.
How Scroogenie adapts DCF
Scroogenie does not apply one set of assumptions to every company. It uses public financial data to reflect differences in industry and cash-flow characteristics.
- Industry-specific growth and discount rates. Industry baselines reflect different growth paths and business risks. Standard industries use a three-year explicit period, while high-growth industries use five years.
- A range instead of one number. FCF levels and growth assumptions are separated into conservative, base and optimistic scenarios.
- Net assets are included. The present value of future cash flow is considered together with the net assets already accumulated by the company.
- Negative FCF is not extended forever. Scroogenie removes terminal value and deducts the present value of three years of expected cash burn from net assets. NAV becomes the baseline when a reasonable FCF estimate is unavailable.
Regular DCF and negative-FCF or NAV sections use different calculation bases. They should be read as changes in cash-generation capacity and financial condition, not as one continuous series.
Markets set the price today, but value begins with the cash a company can create tomorrow.