Discounted Cash Flow (DCF) is a fundamental valuation methodology that estimates the intrinsic value of an investment by calculating the present value of its expected future cash flows — discounting them at an appropriate rate that reflects the investment's risk and the time value of money. The core principle is that a rupee received in the future is worth less than a rupee received today — the further in the future a cash flow, and the higher the risk, the lower its present value. The DCF formula is: Intrinsic Value = Σ [Free Cash Flow_t ÷ (1 + WACC)^t] + Terminal Value ÷ (1 + WACC)^n, where WACC is the Weighted Average Cost of Capital. DCF analysis requires projections of revenue growth, operating margins, capital expenditure, working capital changes, and the terminal growth rate — all of which involve significant assumptions and estimation uncertainty. In Indian equity analysis, DCF models are the preferred valuation framework for quality growth businesses with predictable, compounding free cash flows — particularly software services companies, FMCG leaders, private sector banks (using dividend discount models), and healthcare companies. The sensitivity of DCF valuations to changes in WACC and terminal growth rate — which small changes in assumptions produce dramatically different intrinsic values — requires investors to use DCF as one input among multiple valuation metrics rather than the sole determinant of investment decisions.
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