A DCF is the easiest valuation method to build and the easiest one to get picked apart in front of a lender or an investment committee. Anyone can project five years of cash flow, pick a discount rate, and land on a number. The math is never the hard part. The assumptions underneath it are.
This is a companion to our guide on SDE vs EBITDA, which covers the multiple-based approach. Here we go one level into the DCF itself, because a DCF that cannot survive one pointed question is worse than no DCF at all. It looks rigorous, and it isn't.
Why DCFs get torn apart
A DCF fails in the room for one reason almost every time: the assumptions were picked to hit a number, not derived from the business in front of you. Three inputs do nearly all the damage.
- A growth rate with no basis in the last three years of trading.
- A terminal value doing 60 to 80 percent of the total enterprise value, treated as a formality instead of the single biggest assumption in the model.
- A discount rate chosen to land on a target price instead of to reflect what the business actually risks.
None of these breaks a DCF on its own. What breaks it is the moment someone across the table asks where a number came from and the honest answer is that it made the total come out right.
The three assumptions that decide the outcome
A DCF has exactly three moving parts worth arguing about: the growth rate, the discount rate, and the terminal value. Get the mechanics right and you can still land on a number nobody will defend, because mechanics were never the issue.
Growth rate: grounded in what the business has actually done
The projection should start from the trailing three years of documented revenue, not a target. If the business grew 4, 5, and 4 percent over the last three years, a 5 percent near-term projection is defensible. A 15 percent projection with nothing in the trailing history to support it is not, no matter how good the story sounds.
Tapering matters too. A growth rate that runs at 8 percent through year five and then drops straight to a 3 percent terminal rate is a seam anyone can see. Taper it down year over year so the terminal rate reads as a continuation of the trend, not a cliff.
A discount rate built from named risk
The discount rate is where most DCFs quietly fail, because it is the easiest input to reverse-engineer toward a target price and the hardest one for a reader to check without doing the work themselves.
Each piece should be named, not picked. A sub-$10M business carries meaningfully more risk than a public index, which is why "we used a 12 percent discount rate because that is what public comps use" collapses under one follow-up question. If one customer is over 30 percent of revenue, name that as a specific premium. If the owner personally holds every vendor relationship, name that too. A discount rate assembled from named risks survives scrutiny. A discount rate that is just a round number does not.
For a sub-$10M business, that build-up commonly lands in the high teens to low twenties, well above the 8 to 10 percent often used for large, stable public comps. If your rate is close to a public-market number, ask what specific risk you dropped to get there.
The terminal value cannot work alone
Most five-year DCFs spend four years projecting cash flow and then hand the majority of the total value to a single formula covering everything after year five.
As a rule of thumb, this one formula accounts for 60 to 80 percent of the entire enterprise value in a five-year DCF, which means it deserves more scrutiny than the other four years combined and typically gets less. The fix is not a better formula. It's a cross-check: take the same final-year cash flow or EBITDA and apply a realistic exit multiple instead, the kind of range covered in SDE vs EBITDA, then discount that back to today. If the perpetuity terminal value and the multiple-based terminal value land in the same neighbourhood, the assumptions are internally consistent. If they are wildly apart, one of them, usually the growth rate or the discount rate, is wrong.
A worked example, checked two ways
Take a service business with $500K in trailing EBITDA and free cash flow of $310K in year one, growing 5 percent through year three and tapering to a 3 percent terminal rate by year five. Built up from named risk (customer concentration, a thin management bench, single-location dependency), the discount rate lands at 19 percent.
Year 2 FCF: $325,500
Year 3 FCF: $342,000
Year 4 FCF: $356,000
Year 5 FCF: $367,000
Path A, the perpetuity terminal value:
Discount all five years of cash flow plus that terminal value back to today at 19 percent and the enterprise value comes to roughly $2.01M.
Path B, the exit-multiple cross-check: apply a 4.0x multiple, the low end of the EBITDA range for a business this size with real concentration risk, to a projected year-five EBITDA of roughly $620K.
That path lands at roughly $2.06M.
The two paths land within about 3 percent of each other, not on top of each other, and that is the actual tell. Close agreement between a perpetuity terminal value and an independent exit-multiple cross-check means the assumptions describe the same business from two directions. Landing on the exact same number to the dollar is not a sign of rigour. It is usually a sign the model was built backward from an answer. (Every figure in this section is a worked example, recomputed on 15 October 2026: the five discounted cash flows plus the perpetuity terminal value sum to $2.01M, and with the exit-multiple terminal value to $2.06M.)
Where diligence actually happens
The clean example above hides the real work, which is stress-testing the inputs before anyone trusts the output.
- Run the sensitivity, not just the base case. Show what the enterprise value does if growth comes in 2 points lower or the discount rate runs 2 points higher. A DCF with no sensitivity table is a DCF that has never been pressure-tested by its own author.
- Document every named risk in the discount rate. Customer concentration, owner dependence, single-location exposure, whatever earns its premium should be traceable to something in the business, not asserted.
- Always run the cross-check. A DCF presented without a comparable multiple-based sanity check is a DCF asking to be trusted on faith.
- Reconcile against SDE or EBITDA. The SDE vs EBITDA math and a properly built DCF should describe the same business from different angles. If they disagree by a wide margin, that disagreement is the finding, not a rounding error to wave off.
Educational guide, not advice. The methods, ranges, and worked example here are industry rules of thumb for general education and planning. They are not a formal valuation, appraisal, or financial advice. A defensible, audit-ready valuation requires a review of your actual financials and circumstances.
The takeaway
A DCF is not defensible because the spreadsheet is elegant. It is defensible because every input traces back to something real: a growth rate grounded in the trailing three years, a discount rate built from named risks instead of a round number, and a terminal value that survives being checked a second way. Do that and the model stops being a guess dressed up in formulas. It becomes a number you can walk a lender, a seller, or an investment committee through, line by line.
If you want to see a DCF-consistent range for a specific business, our free valuation calculator runs the multiple-based math in a couple of minutes and gives you a starting point to pressure-test against.
How Acquiror AI does this
The Valuation module in Acquiror AI runs the DCF from per-year revenue, EBITDA, capex, cash taxes and working capital, with a Gordon Growth or exit-multiple terminal value, so the two paths in this article are two settings on one model rather than two spreadsheets. Sensitivity bands on the discount rate, the terminal growth rate and the exit multiple produce the table a reviewer asks for, the result is triangulated with comparable multiples and adjusted net assets, and every change to an assumption is logged. The earnings the model starts from come from a locked Quality of Earnings period, so the DCF and the multiple describe the same business by construction.