01 / Learn the method
Learning outcomes
Compare two valuation lenses and expose sensitivity instead of hiding it. Calculate the result, reconcile it and communicate its limitations.
Method
Discount unlevered free cash flow at a consistent enterprise discount rate. With end-of-year cash flows and perpetual growth, terminal value at year N is FCF(N) × (1+g) / (r-g), requiring r > g. Discount terminal value back N years. Comparable multiples are a cross-check, not evidence that every business deserves the median.
Smaller worked example
A separate $100 cash flow received in one year has a $90.91 present value at 10%. A terminal value computed at the end of year 3 must be divided by (1+r)^3, not (1+r)^4.
02 / Put it to work
Business context and rules
Fictional Brook Software, valuation date 30 September 2026. All money is USD thousands. The three forecast years have unlevered FCF 100 / 120 / 140 paid at each year end. Base discount rate 10%; perpetual growth 2%. Reference EBITDA 150. Synthetic peer EV / EBITDA values are 5x, 6x, 7x and are already sorted; assume the EBITDA definition is matched. No net debt bridge is required. Sensitivity grid: discount rates 8%, 10%, 12% and terminal growth 1%, 2%, 3%. These are teaching assumptions, not live market estimates.
Original synthetic inputs
| Input | Value | Unit |
|---|---|---|
| Year 1 unlevered free cash flow | 100 | USD thousands |
| Year 2 unlevered free cash flow | 120 | USD thousands |
| Year 3 unlevered free cash flow | 140 | USD thousands |
| Base discount rate | 0.1 | fraction |
| Base terminal growth | 0.02 | fraction |
| Comparable reference EBITDA | 150 | USD thousands |
| Synthetic peer A EV / EBITDA | 5 | multiple |
| Synthetic peer B EV / EBITDA | 6 | multiple |
| Synthetic peer C EV / EBITDA | 7 | multiple |
Required deliverables
Deliver a three-year DCF, a 3×3 sensitivity table, low / median / high comparable EV and a 200-word valuation note. Explain the divergence and name diligence questions on reinvestment, cash conversion and peer comparability. Do not average incompatible results without rationale.
Use formulas for derived amounts and preserve source data. Put narrative deliverables in the workbook response area; expand it as needed. Compare amounts within 0.01 of the stated unit and percentages within 0.1 percentage point. No unsupported balancing plugs.
Workbook structure
The student workbook intentionally leaves the analysis structure open. Build the schedules required above, retain the source inputs, and add formula-based checks. You may add worksheets. The worked solution is one acceptable structure, not the only correct layout.
03 / Review your work
Try the assignment before opening the answer.
Open the worked answer and notes
Three-year DCF - USD thousands
| Measure | Year 1 | Year 2 | Year 3 |
|---|---|---|---|
| Unlevered free cash flow | 100.00 | 120.00 | 140.00 |
| Discount factor | 0.91 | 0.83 | 0.75 |
| Present value | 90.91 | 99.17 | 105.18 |
The unlevered free cash flows are supplied inputs. Terminal value is placed at the end of year 3 and discounted by the year-3 factor.
Enterprise value sensitivity - USD thousands
| Discount / growth | 1% | 2% | 3% |
|---|---|---|---|
| 8% | 1,910.15 | 2,195.93 | 2,596.02 |
| 10% | 1,475.67 | 1,636.36 | 1,842.98 |
| 12% | 1,199.56 | 1,301.02 | 1,425.03 |
Valuation summary - USD thousands
| Measure | Value |
|---|---|
| Terminal value | 1,785.00 |
| PV terminal value | 1,341.10 |
| Enterprise value | 1,636.36 |
| Terminal share | 82.0% |
| Peer low / median / high | 750.00 / 900.00 / 1,050.00 |
Interpretation and recommended actions
Base terminal value is 1,785 (USD thousands). Base EV is about 1,636.36, compared with 750 / 900 / 1,050 from peers. Most DCF value is terminal, so the implied mature cash conversion and reinvestment deserve scrutiny. Present both ranges with assumptions; do not call the peer range observed market evidence because it is synthetic. A higher perpetual growth rate must be consistent with the reinvestment needed to support it.
Scoring rubric - 100 points
| Dimension | Points | Awarding guidance |
|---|---|---|
| Calculation | 40 | Yearly DCF 12; terminal value 8; sensitivities 12; comparable values 8. |
| Interpretation | 25 | Correct application of the case rules 10; explain the business decision 10; identify evidence or limitations 5. |
| Controls / audit trail | 20 | Traceable formulas 8; independent reconciliation 8; explicit units and signs 4. |
| Communication | 15 | Decision and numerical headline 5; actions with owners and evidence 5; concise response covering all required deliverables 5. |
Award method credit after an isolated arithmetic error rather than repeatedly deducting for it. Equivalent account labels and well-supported alternative recommendations are acceptable. Numerical tolerance is 0.01 in the stated units; no universal passing score is prescribed.
Common mistakes
Discounting terminal value one extra year; using a growth rate at or above the discount rate; treating synthetic peers as market evidence.
Staged hints
Calculate yearly PV first. Put terminal value at year 3. The 10% / 2% grid result must equal the base DCF.
Instructor notes
Prerequisites: Free cash flow, discounting and multiples. The total duration of 90 minutes is a planning estimate, not a tested completion time. Allocate class time according to prior knowledge and reserve time for discussion of the decision and evidence.
For a simpler class, provide the model structure and work through one driver. For an extension, change one operational assumption and require a new reconciliation and recommendation. Verify the new key before distributing any variant. Open files in the intended spreadsheet application before class. Solutions are learning resources, not secure hiring examinations.
Decision
Present the DCF and comparable ranges separately and investigate why the DCF is materially higher.
Evidence and reasoning
About 82% of base DCF value comes from the terminal period. That makes sustainable cash conversion and the reinvestment required for growth decisive assumptions, not minor sensitivity settings.
What would change the conclusion
Reinvestment needs, cash conversion, risk or peer comparability could change the valuation. Reject growth at or above the discount rate rather than reporting a misleading perpetuity value.
Related learning
Version 1.1. Synthetic teaching case. Completion time is an estimate.