DCF interview questions: 20 real questions

001Walk me through a DCF.

core

• Why unlevered rather than levered FCF?
• What growth rate for terminal value and why?

002How do you calculate WACC, and how do you get cost of equity?

intermediate

• Why is debt cheaper than equity?
• Where does beta come from for a private company?

003Two ways to calculate terminal value, and what long-term growth rate would you use?

intermediate

• Your TV is 90% of total value, is your DCF broken?

004If interest rates rise, what happens to your DCF value?

intermediate

• Any offsetting effects worth mentioning?

005When is a DCF NOT the right tool?

intermediate

• How WOULD you value a pre-revenue company?

006Final-year FCF $100M, WACC 10%, terminal growth 3%. Terminal value?

intermediate

• Now discount it back 5 years at 10%, roughly? (≈$914M; 1.1^5 ≈ 1.61)

007What are the main criticisms of the DCF method, and how would you respond to each?

intermediate

• Which of those four is hardest to defend against?
• How does cross-checking against comps address the sensitivity criticism specifically?

008A company has $40 million of debt at a 6% cost of debt and $60 million of equity at a 16% cost of equity; ignore taxes. What is its WACC? Now suppose debt rises to $90 million while equity stays at $60 million. What happens to WACC?

intermediate

• Why does the cost of equity itself rise as leverage increases, even though equity holders aren't the ones lending?
• How would introducing a corporate tax rate change the calculation?

009In the perpetuity growth method for terminal value, why do we divide next year's free cash flow by the discount rate minus the growth rate? Give me the intuition, not just the formula.

intermediate

• Why does the numerator use final-year FCF grown one more year rather than final-year FCF itself?
• What happens to the formula as g approaches r, and what does that tell you about sanity-checking terminal growth assumptions?
• How would you cross-check a perpetuity-growth terminal value for reasonableness?

010Difference between levered and unlevered free cash flow, and which discount rate goes with each?

advanced

• Why do most bankers use the unlevered version?

011What is beta, and why do you unlever and relever it?

advanced

• Why is levered beta higher than unlevered?

012Depreciation increases by $10. What happens to unlevered FCF?

advanced

• So why not depreciate everything instantly? What constrains it?

013What is the mid-year convention and why use it?

advanced

• Directionally how much does it raise a typical DCF value?

014Which moves your DCF more, one point of WACC or one point of terminal growth?

advanced

• What does it tell you if your valuation only works at a 4% terminal growth rate?

015There's a circularity in computing WACC. What is it and how do you resolve it?

advanced

• Why use a target structure rather than today's actual structure?

016How do you value a company with negative free cash flow?

advanced

• Why is the Gordon growth method dangerous here?

017In year 5 of your DCF, EBITDA is $600M and you assume a 14x exit multiple for terminal value. Year-5 unlevered FCF is $400M and WACC is 10%. What perpetuity growth rate does your exit multiple imply, and why does this check matter?

advanced

• Why can't a perpetuity growth rate exceed long-run GDP growth?
• If you lowered g to 2.5%, roughly what exit multiple would that imply directionally?
• Which terminal value method would you present to a client, and why?

018In the terminal year of a DCF using the perpetuity growth method, depreciation increases by $15. Tax rate is 25%, WACC is 10%, and terminal growth is 0%. What happens to terminal value?

advanced

• Why should depreciation approximate capex in the terminal year?
• What if the tax rate were zero, what happens to terminal value then?
• Same question, but the company has large NOLs and pays no cash taxes for the next decade. Now what?

019As a company keeps adding more and more debt to its capital structure, what happens to its WACC?

advanced

• All else equal, should a $100M market cap company or a $100B market cap company have the higher WACC, and why?
• If the corporate tax rate increases, what happens to WACC, all else equal?
• Why does the cost of equity rise as leverage increases even though shareholders are not the ones lending?

020A company has EBIT of $200, interest expense of $20, a 25% tax rate, D&A of $30, a $10 increase in working capital, and CapEx of $40. Compute unlevered free cash flow and compare it to CFO minus CFI from the cash flow statement. Do they match - and is CFO a levered or unlevered metric?

advanced

• Why is the add-back after-tax rather than the full $20 of interest?
• If the company had no debt, would the two measures agree? Why?
• Which of the two would you discount at WACC, and what would you pair with the other?