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valuation · 6 min read

WACC and terminal value: the assumptions behind a DCF

Sergei MochtchenkovSergei Mochtchenkov, CFA

Published · Updated

Abstract navy and gold composition illustrating wacc and terminal value: the assumptions behind a dcf

In brief

Match the discount rate to the currency and risk of the cash flows. For an enterprise DCF, discount unlevered cash flow at WACC and test the terminal assumptions separately. Perpetual growth must remain below the discount rate, with reinvestment supporting that growth. A precise output is not a precise valuation: compare a range of defensible assumptions and disclose the simplified model’s limitations.

Key takeaways

  • Match the discount rate to the currency and risk of the cash flows.
  • Reconcile the inputs to source records and make assumptions explicit.
  • Use the result to frame questions, not as an assurance conclusion.

Match the discount rate and cash flows

Enterprise DCF uses unlevered free cash flows with a rate reflecting the financing mix and operating risk. Equity cash flows require a cost of equity. Match currency, nominal or real assumptions and valuation date. A generic rate copied from another business does not capture differences in leverage, size, country exposure or business risk.

Illustrative worked example

An unlevered cash-flow forecast cannot be discounted at a debt coupon simply because the business has a loan.

Stable growth requires reinvestment

In a Gordon-growth terminal value, next-year cash flow is divided by WACC minus perpetual growth. WACC must exceed growth. The stable-state forecast needs sustainable margins and enough reinvestment to support growth; the formula does not justify assumptions on its own.

Illustrative worked example

Terminal cash flow $100,000, WACC 12% and growth 2% gives $1 million terminal value at the end of the forecast period, before discounting to today.

Compare a range and disclose simplifications

Test rates and terminal assumptions together. Inspect the share of value contributed by terminal cash flows and cross-check with comparable economics. The site DCF tool is simplified: it omits a full working-capital and depreciation schedule and is not a complete appraisal.

Illustrative worked example

Increasing WACC from 12% to 14% at 2% growth reduces the same terminal value from $1 million to about $833,333.

Frequently asked questions

No. These are educational methods and hypothetical examples. Apply the actual records, agreement and intended use before making a decision.

Gather reconciled monthly records, document definitions and identify missing evidence before selecting assumptions or interpreting the output.

Educational content — not an audit, assurance opinion, or investment or legal advice.

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Investor-Ready Model Checklist

  • ✓ Reconcile opening balances to the accounts.
  • ✓ Separate inputs, calculations and outputs.
  • ✓ Link the income statement, balance sheet and cash flow.
  • ✓ Document revenue, cost and working-capital drivers.
  • ✓ Include downside and funding scenarios.
  • ✓ Test balance checks and cash roll-forwards.
  • ✓ Reconcile enterprise value to equity value.
  • ✓ Track actuals against plan and document changes.
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