A discounted cash flow model is the most common technical interview question in investment banking recruiting. Every first-round interview at a bulge bracket or elite boutique will ask some version of it. Most students answer it wrong, not because the mechanics are hard, but because they recite components instead of walking through a chain of reasoning.
Here is the answer structure that actually lands.
What the question is actually testing
When an interviewer says "walk me through a DCF," they are not asking you to list what a DCF contains. They are asking you to demonstrate that you understand why each step exists and how the pieces connect.
The most common failure: enumerating the steps in order without explaining the logic. "First you project revenues, then you get to EBITDA, then you calculate free cash flow..." That answer tells the interviewer you memorized a framework. It does not tell them you understand valuation.
The answer structure, step by step
Step 1: Project free cash flows
Start here: "I am going to project the company's unlevered free cash flows over a discrete forecast period, typically five to ten years."
Unlevered free cash flow is:
EBIT × (1 - tax rate) + D&A - CapEx - changes in working capital
Note that you start with EBIT (not EBITDA, not net income). EBIT is operating income. You tax it to get NOPAT (net operating profit after tax), add back the non-cash D&A charge, and subtract the actual cash reinvested in the business (CapEx and working capital changes).
Why unlevered? Because a DCF values the enterprise, not the equity. Financing costs (interest expense) are excluded from the cash flows and reflected instead in the discount rate.
Step 2: Calculate terminal value
At some point you stop projecting explicitly and estimate the value of all remaining cash flows. Two methods:
Gordon Growth Model: TV = (final year FCF × (1 + g)) / (WACC - g), where g is a long-run sustainable growth rate, typically near GDP growth or below.
Exit Multiple: TV = final year EBITDA × a market-derived multiple.
The thing most students miss: terminal value often represents 60 to 80 percent of the total enterprise value. The assumptions driving it deserve explicit discussion. An interviewer who hears you ignore this is forming a judgment.
Step 3: Discount to present value
Discount all projected cash flows and the terminal value back to today using WACC (weighted average cost of capital):
WACC = Ke × (E / (D + E)) + Kd × (D / (D + E)) × (1 - t)
Where Ke is the cost of equity (typically from CAPM: risk-free rate + beta × equity risk premium), Kd is the pre-tax cost of debt, and t is the tax rate. WACC represents the blended required return across the capital structure.
Step 4: Get to equity value
Equity Value = Enterprise Value - Net Debt
Enterprise value is the sum of all discounted cash flows. Net debt is total debt minus cash and cash equivalents. This gives you equity value. Divide by diluted shares outstanding to get equity value per share.
How to answer it well
The difference between a good answer and a great answer is the connections. Every step should flow from the one before it with a one-sentence explanation:
"I'm projecting unlevered free cash flows because I want to value the business independent of its financing structure. I'm discounting those flows at WACC because that reflects the required return to all capital providers. I add back D&A because it is a non-cash charge, and I subtract CapEx because that is the actual cash going back into the business."
That is the reasoning a trained analyst would give. That is the answer that gets you to the next round.
Frequently asked questions
Why do you use EBIT and not EBITDA as the starting point for FCF? D&A is added back explicitly later in the FCF calculation. Starting with EBIT and then adding D&A gives the same result as starting from EBITDA and subtracting taxes — but starting from EBIT makes the tax effect cleaner: you are taxing operating income before the non-cash charge, which is how most models are built.
What growth rate should I assume for the Gordon Growth Model? A defensible range is inflation to nominal GDP growth, typically 2 to 3 percent for a mature US business. Using a rate higher than the long-run GDP growth rate implies the company eventually grows larger than the economy, which is not sustainable.
What is the most common mistake in a DCF interview answer? Using net income instead of unlevered free cash flow, or forgetting to subtract the CapEx and working capital investment when building FCF. Both errors mix up what you are valuing (the enterprise) with the returns to equity holders only.
When is a DCF most useful vs least useful? Most useful for companies with stable, predictable cash flows and a reasonable history of financial performance. Least useful for early-stage companies with no earnings, capital-intensive cyclicals where near-term cash flows are noisy, or businesses where the value is in optionality the model cannot capture.
Ready to answer this out loud and hear what you got wrong? See the plans to access the drill-and-feedback flow.