I asked candidates to walk me through a DCF more times than I can count and here is the uncomfortable truth about how it was scored: the mechanics were worth less than everyone assumed. By interview stage, most candidates can recite the steps. What separated them was structure, precision at three specific checkpoints and what happened in the follow-ups. This article is the question from the scoring side.
The 60-second model answer
The answer that scores · roughly 60 seconds
A DCF values a company from the cash it will generate, independent of what the market currently pays for it. I forecast unlevered free cash flow over an explicit period, usually five to ten years: EBIT taxed at the effective rate, plus depreciation and amortisation, less capital expenditure, less the increase in net working capital. I discount those flows at the weighted average cost of capital, because they belong to all providers of capital. Beyond the explicit period I estimate a terminal value, by perpetuity growth or an exit multiple and discount it on the same basis. The sum is enterprise value; subtracting net debt and adjusting for other claims bridges to equity value. Then I sanity-check the output against comparables and test the sensitive assumptions.
Notice the shape: purpose first, then mechanics, then judgement. The weakest answers start with 'first you project revenue', which signals memorisation without a frame; the interviewer has no idea whether you know why any of it is happening. One sentence of purpose at the top changes how everything after it is heard.
The three checkpoints where marks actually move
- The unlevered free cash flow definition. This is checkpoint one and it is pass-fail. Interest must be absent, tax applied to EBIT, working capital as a change not a level. Levered-unlevered confusion here ends the technical portion in practice, because it suggests the candidate is assembling remembered fragments rather than reasoning about whose cash this is. The whose-cash logic is the same one underneath the enterprise-versus-equity-value question, covered in its own article on this site.
- One sentence of real understanding at WACC. Nobody expects a derivation. The scoring line is knowing why WACC: the flows are unlevered, so the rate must blend all capital providers' required returns, weighted at market values. Candidates who can add that the cost of equity typically comes from CAPM have said enough; the full mechanics live in the WACC article.
- Terminal value humility. The strongest differentiator available. Terminal value routinely carries 60-80% of the total and the candidate who volunteers that, unprompted, together with one sanity check, cross-checking the implied exit multiple against the perpetuity growth assumption, has just demonstrated they understand where the model is fragile. The terminal value article covers the checks in full.
The follow-ups that separate candidates
The walk-through is the entry fee; the follow-ups are the exam. The recurring set: when is a DCF the wrong tool (early-stage companies with no stable cash flows, banks and insurers where working capital and leverage mean something different, cyclicals valued off peak earnings). Which assumption is the output most sensitive to (the discount rate and terminal assumptions, which is exactly why they get the scrutiny above). How would you sanity-check the result (against trading and transaction comps and by asking what the implied multiples say). And occasionally the practical one, what would you actually build first in Excel, which is where this article hands over to the modelling tests piece.
The fumbles I saw every season
Discounting the terminal value from the wrong year. Reciting mid-year conventions without being able to say what they correct for, a flourish that invites a follow-up the candidate then fails. Forgetting the bridge entirely and presenting enterprise value as the answer to an equity question. And answering at uniform speed for four minutes, which buries the three checkpoints that were actually being scored inside a wall of memorised connective tissue. Slow down at the checkpoints; they are the answer.
Rehearse the sixty seconds out loud until the structure is automatic, then have someone run the follow-ups at you cold; if you take one deal from your deal discussions and run this framework on it, per the talking-about-a-deal article, the whole thing stops being theory. And if you want it scored the way I scored it, with the follow-ups live, that is the IBD Recruiting Review.
FAQ
How do I walk through a DCF in an interview?
Purpose first, then mechanics, then judgement: unlevered free cash flows over five to ten years, discounted at WACC, plus a terminal value, summing to enterprise value, bridged to equity value, sanity-checked against comps.
What is the most common DCF mistake in interviews?
Levered-unlevered confusion: interest inside free cash flow, or discounting equity flows at WACC. It signals assembled fragments rather than an understanding of whose cash is being valued.
When is a DCF the wrong valuation tool?
Early-stage companies without stable cash flows, banks and insurers where leverage is the business and cyclicals at peak earnings.
Former Executive Director in TMT Investment Banking at Nomura and M&A banker at BNP Paribas. Top-rated mentor with 300+ sessions. About
