What Is Discounted Cash Flow?
Discounted Cash Flow (DCF) is a valuation method that estimates a company's intrinsic value by projecting its future cash flows and discounting them back to present value. The core principle: a dollar received in the future is worth less than a dollar today, because today's dollar can be invested.
Formula
DCF Value = CF1/(1+r)^1 + CF2/(1+r)^2 + ... + CFn/(1+r)^n + TV/(1+r)^n
Where:
- CF = Free Cash Flow in each period
- r = Discount rate (typically Weighted Average Cost of Capital)
- TV = Terminal Value (value beyond projection period)
- n = Number of periods
Simplified Example
Projecting 5 years of cash flow with a 12% discount rate:
| Year | Projected FCF | Discount Factor | Present Value |
|---|---|---|---|
| 1 | $100K | 0.893 | $89.3K |
| 2 | $130K | 0.797 | $103.6K |
| 3 | $170K | 0.712 | $121.0K |
| 4 | $220K | 0.636 | $139.8K |
| 5 | $280K | 0.567 | $158.8K |
| Terminal | $3.5M | 0.567 | $1,984.5K |
| Total DCF | $2,597K |
Strengths and Weaknesses
| Strengths | Weaknesses |
|---|---|
| Based on fundamentals, not market sentiment | Highly sensitive to assumptions |
| Forward-looking | Terminal value often dominates (70%+) |
| Customizable to specific scenarios | Requires accurate revenue projections |
| Works for any cash-generating asset | Discount rate selection is subjective |
Choosing the Discount Rate
Higher discount rates reflect higher risk:
| Business Type | Typical Discount Rate |
|---|---|
| Large public SaaS | 8% – 12% |
| Growth-stage SaaS | 15% – 25% |
| Small business/SMB SaaS | 20% – 35% |
| Early-stage/unproven | 30% – 50% |
DCF in AI-Run Companies
DCF models for AI-run companies require adjusted assumptions. Operating costs scale sublinearly with revenue (AI costs grow slower than revenue), making future cash flows potentially more predictable and higher-margin than traditional companies. However, the risk of AI model disruption (a new model making the current approach obsolete) may warrant a higher discount rate.
On EvolC, DCF analysis helps investors move beyond simple multiples and estimate what an AI-run company is fundamentally worth based on its projected cash generation.