In a discounted cash flow valuation, which sequence correctly leads to enterprise value?

• A. Calculate the enterprise value using market price, with no cash flow data
• B. Estimate future sales; apply a multiplier to derive value
• C. Forecast free cash flows, determine discount rate (WACC), calculate present value of cash flows and terminal value, sum to enterprise value; adjust for debt/cash
• D. Sum current cash balances to determine value

Answer: (C)

In a discounted cash flow valuation, you value the whole firm by forecasting the cash flows available to all providers of capital and then discounting them back to today. Start by projecting free cash flows to the firm for a defined horizon. Then choose the discount rate that matches this scope—typically the weighted average cost of capital, which reflects the cost of both debt and equity. Next, compute the present value of those forecasted cash flows and also estimate a terminal value to capture the value of cash flows beyond the explicit forecast. Add the present values of the explicit forecast and the terminal value to arrive at the enterprise value. Finally, adjust for non-operating items such as cash and debt to move from enterprise value to equity value if needed.