DCF Interview Questions: The Ones That Actually Come Up

"Walk me through a DCF"

The answer has a fixed shape: project unlevered free cash flow for an explicit forecast period (typically 5-10 years), discount each year's cash flow back to present value using the weighted average cost of capital (WACC), calculate a terminal value for cash flows beyond the forecast period (via a perpetuity growth rate or an exit multiple), discount the terminal value back to present value, and sum the two to get enterprise value. From enterprise value, subtract net debt and other claims to arrive at equity value, then divide by shares outstanding for a per-share value.

Why unlevered free cash flow, not net income?

Because a DCF discounted at WACC values the company's operations independent of how they are financed — unlevered free cash flow excludes interest expense, keeping the cash flow stream capital-structure-neutral so it matches a capital-structure-neutral discount rate. Using net income (which already reflects interest) against WACC would double-count the cost of debt.

Terminal value follow-ups

Terminal value frequently represents 60-80% of total implied enterprise value in a DCF, which is exactly why interviewers probe it — a model that is 70% driven by an assumption about growth in perpetuity is only as credible as that one number.

• "Why might terminal value be too large a share of total value?" — because the further-out, harder-to-forecast portion is doing most of the work; a common check is to compare implied exit multiple (from the perpetuity method) against real trading comps to sanity-check it.
• "Perpetuity growth vs exit multiple method — which do you trust more?" — exit multiple is often viewed as more grounded because it anchors to observable market multiples, though it implicitly assumes the market's current view on comparable companies holds at the terminal date; perpetuity growth is more theoretically pure but sensitive to small changes in the growth assumption.
• "What terminal growth rate would you use and why?" — typically capped near long-run GDP or inflation growth (roughly 2-3%), since no company can grow faster than the broader economy forever without eventually becoming the entire economy.

WACC follow-ups

WACC blends the cost of equity (via CAPM: risk-free rate + beta × equity risk premium) and after-tax cost of debt, weighted by their proportions in the capital structure.

• "What happens to WACC if leverage increases?" — cost of equity rises (equity holders bear more risk), but up to a point the tax shield on debt and debt's lower absolute cost can offset that, so the net effect on WACC is not always simply "up" or "down" — it depends on where leverage sits relative to the optimal range.
• "Why use levered beta from comps and then re-lever it?" — comps have different capital structures from your target, so you unlever each comp's beta to isolate business risk, average the unlevered betas, then re-lever using your target's own capital structure.

The trap most candidates fall into

Reciting the five steps fluently, then freezing when asked "why" for any individual step. Interviewers use the follow-ups specifically to separate memorisation from understanding — practise being able to justify every input, not just list them in order.