“Walk me through a DCF”: why it's always asked and how to answer it well
Walk me through a DCF is the most predictable banking interview question. Here's why it's asked and what separates a strong answer from a recited one.
4 min read · RoundReady
Almost every investment banking interview includes some version of “walk me through a DCF”. Everyone knows it's coming. Most candidates have a memorised answer ready. So why do interviewers keep asking it?
Because a question everyone has prepared is a very good filter. When every answer contains the same steps, the differences are easy to hear: who understands why each step exists and who is reciting a list.
What the question is really testing
A DCF pulls together most of what a junior banker needs to know: the three statements, cash flow, the cost of capital and the bridge from enterprise value to equity value. If you can explain it clearly in about a minute, the interviewer learns that your foundations are solid. If you stumble, they know where to dig.
It also tests communication. Analysts explain models to people who haven't built them. A tight, ordered answer is a small sample of that skill.
A good answer in about 60 seconds
“A DCF values a business as the present value of the cash it will generate. First I'd project unlevered free cash flow for five to ten years: EBIT less taxes, plus depreciation and amortisation, less capex and less the increase in working capital. Then I'd estimate a terminal value for everything after the projection period, using either a perpetuity growth rate or an exit multiple. I'd discount both back at the weighted average cost of capital, because unlevered cash flow is available to both debt and equity holders. That gives enterprise value. To get to equity value I'd subtract debt and add cash, then divide by diluted shares for a value per share.”
Notice what's in there beyond the steps. It says why the cash flow is unlevered and why WACC is the right rate. Those two “becauses” are what interviewers listen for, since they're exactly what a recited answer leaves out.
The insight most candidates miss
A strong candidate knows where the value in a DCF actually comes from. In most models it's the terminal value, often well over half of the total. Here's a simple version for a fictional company, Harbourline Logistics.
Roughly 70% of the value sits in the years we didn't forecast. Now nudge the growth rate from 2% to 3%. The terminal value becomes 103 / 0.07 = 1,471.4, worth 913.6 today. Enterprise value rises to about 1,251. One percentage point on an assumption nobody can really know moves the answer by roughly 11%.
That's why bankers show DCF outputs as a range on a sensitivity table rather than a single number. Mentioning this unprompted signals that you see the model as a tool for judgement, not a machine that produces the truth.
The follow-ups to have ready
Once you've finished, expect the interviewer to pull on one thread. The common ones are short and worth practising aloud.
- Why use unlevered rather than levered free cash flow? Because we want the value of the whole business independent of how it's financed. Levered cash flow would be discounted at the cost of equity to get equity value directly.
- Perpetuity growth or exit multiple? Both are common. The growth method rests on theory, the multiple method on what the market pays today. Bankers often run both as a cross-check.
- What growth rate is sensible? Something at or below long-run nominal growth in the economy, because no company can outgrow the economy forever.
- What happens to value if WACC rises? It falls, since future cash flows are discounted more heavily.
Stop talking at the right moment
The best answers end cleanly at value per share and leave room for questions. Going on into mid-year conventions and stub periods rarely earns credit and often creates an opening for a question you can't answer. Say the steps, say the two reasons, then stop.