How to Answer "Walk Me Through a DCF" in IB Interviews

Why This Question Matters

"Walk me through a DCF" is one of the most common technical questions in investment banking interviews. If you're interviewing for front office roles in banking, private equity, or equity research, you can virtually guarantee this question will be asked.

The question tests multiple competencies simultaneously. Technical knowledge (do you understand the mechanics of valuation?), communication skills (can you explain complex concepts clearly?), structured thinking (can you organize a multi-step process logically?), and interview composure (can you deliver under pressure without rambling?).

A strong answer demonstrates you understand how intrinsic valuation works, you can build financial models, and you think like an investor evaluating what a business is truly worth. A weak answer, even if your resume is perfect, signals you lack the technical foundation needed for the role.

Understanding how the three financial statements link together is foundational because DCF modeling requires projecting all three statements to derive free cash flows, making that knowledge directly applicable here.

What Interviewers Are Really Testing

When someone asks you to walk through a DCF, they're evaluating several things:

1. Do You Actually Understand DCF?

This isn't about memorizing steps. Interviewers want to know if you grasp why we discount cash flows, what the output represents, and how it differs from other valuation methods. Surface-level memorization is obvious and fails immediately.

2. Can You Explain It Clearly?

Investment banking requires distilling complex financial analysis into clear narratives for clients and senior bankers. If you can't explain a DCF in 90 seconds without getting lost in details or stumbling over steps, you're not ready for the communication demands of the job.

3. Do You Know When to Go Deep vs. Stay High-Level?

Strong candidates start with a concise high-level overview and then provide detail when asked. Weak candidates either stay too vague throughout or dive into minutiae immediately and lose the forest for the trees.

4. Have You Actually Built One?

There's a huge difference between someone who has built DCF models in Excel and someone who just read about them. Interviewers can tell. Your confidence, the way you describe assumptions, and how you handle follow-up questions reveal whether you have hands-on experience.

The Quick Answer (30 Seconds)

Before we go deeper, here's the super-fast answer you should be able to deliver smoothly:

"A DCF values a company based on the present value of its future cash flows. I'd project unlevered free cash flow for 5-10 years based on assumptions about revenue growth, margins, capex, and working capital. Then I'd calculate a terminal value, typically using an exit multiple approach. I'd discount both the projected cash flows and terminal value back to today using the company's WACC as the discount rate. The sum gives me enterprise value, which I can bridge to equity value and divide by shares outstanding to get an implied share price."

Time: 30-40 seconds when delivered smoothly

That's your baseline. Nail that first, then we'll build depth.

The Complete Framework (90 Seconds)

Here's the structured, step-by-step walkthrough that shows deeper understanding while remaining clear and organized:

Step 1: Project Free Cash Flows

"First, I build a projection model for the company's financial statements, typically 5-10 years depending on visibility and stability. For mature businesses I'd use 5 years; for high-growth companies with less predictability, sometimes longer.

I start with revenue projections based on historical growth, industry trends, and company guidance. Then I forecast the income statement down to EBIT, applying assumptions about margins, operating expenses, and cost structure.

To get to unlevered free cash flow, I take EBIT, adjust for taxes (using the marginal tax rate), add back non-cash charges like D&A, subtract capex, and adjust for changes in net working capital."

The formula:

Step 2: Calculate Terminal Value

"After the projection period, the company continues operating. The terminal value captures all cash flows beyond Year 5 or 10.

There are two main approaches. The perpetuity growth method assumes free cash flow grows at a constant rate forever, typically 2-3% matching long-term GDP or inflation. The exit multiple method applies a valuation multiple like EV/EBITDA to the final year's EBITDA, based on comparable company multiples.

In investment banking, the exit multiple approach is more common because it's grounded in observable market data rather than assumptions about perpetual growth rates."

Perpetuity growth formula:

Exit multiple formula:

Step 3: Determine the Discount Rate (WACC)

"The discount rate reflects the time value of money and risk. For an unlevered DCF, I use WACC (weighted average cost of capital), which blends the cost of equity and cost of debt based on the company's target capital structure.

Cost of equity is typically calculated using CAPM, based on the risk-free rate, beta, and equity risk premium. Cost of debt is the company's marginal borrowing rate after tax."

WACC formula:

Where $E$ is market value of equity, $D$ is debt, $V = E + D$ is total firm value, $R_e$ is cost of equity, $R_d$ is cost of debt, and $T_c$ is the corporate tax rate.

Step 4: Discount Cash Flows to Present Value

"I discount each year's projected free cash flow and the terminal value back to today using WACC. Year 1 cash flows are discounted by $(1 + \text{WACC})^1$, Year 2 by $(1 + \text{WACC})^2$, and so on. The terminal value is also discounted back from the end of the projection period."

Present value formula:

Step 5: Calculate Enterprise Value and Equity Value

"The sum of all discounted cash flows gives me enterprise value, which represents the value of the entire operating business available to all investors, both debt and equity holders.

To get to equity value, I use the bridge calculation: subtract net debt, subtract preferred stock and minority interests, and add back any non-operating assets like excess cash or investments.

Finally, I divide equity value by diluted shares outstanding to get the implied share price, which I compare to the current trading price to assess whether the stock is undervalued or overvalued."

Bridge formula:

Total time: 75-90 seconds when delivered smoothly and confidently

Key Assumptions to Highlight

When walking through a DCF, interviewers appreciate when you acknowledge the critical assumptions driving the valuation. Mentioning these shows sophistication:

Revenue growth rates: Are you assuming continuation of historical trends, or adjusting for market saturation, competition, or new products?

Margin assumptions: Are margins stable, expanding, or compressing? This depends on operating leverage, pricing power, and cost structure.

Capital intensity: How much capex is required to sustain growth? High capex reduces free cash flow and lowers valuation.

Working capital changes: Growing companies often require significant working capital investment, which is a use of cash that reduces free cash flow.

Terminal growth rate: If using perpetuity growth, 2-3% is typical (matching long-term GDP). Higher rates imply the company grows faster than the economy forever, which is unrealistic.

WACC components: Beta, risk-free rate, market risk premium, and target capital structure all materially affect WACC and therefore valuation.

Exit multiple: If using the exit multiple method, what multiple are you applying and why? It should be grounded in current comparable company valuations.

Common Follow-Up Questions

After your initial DCF walkthrough, expect follow-ups that test deeper understanding. Here are the most common:

Follow-Up 1: "What's the difference between levered and unlevered free cash flow?"

Strong Answer:

"Unlevered free cash flow is cash flow available to all investors (debt and equity holders) before any financing activities. It starts from EBIT, adjusts for taxes, adds back D&A, and subtracts capex and working capital changes. It's capital structure-neutral.

Levered free cash flow is cash available specifically to equity holders after debt obligations. It starts from net income (which already reflects interest expense), adds back D&A, subtracts capex and working capital changes, and reflects any debt repayments or issuances.

For DCF, we typically use unlevered FCF and discount at WACC because we're valuing the entire enterprise. If we used levered FCF, we'd discount at cost of equity instead."

Follow-Up 2: "Why do we add back depreciation?"

Strong Answer:

"Depreciation is a non-cash expense that reduces EBIT but doesn't involve an actual cash outflow. Since we're calculating cash flow, we add it back.

However, we separately subtract capex, which is the actual cash spent on PP&E. So we're not ignoring capital expenditures; we're just separating the accounting treatment (depreciation) from the cash reality (capex).

This also means maintenance capex, which keeps the business running, is critical to forecast accurately. Growth capex for expansion is separate and depends on growth assumptions."

Follow-Up 3: "How would you calculate WACC?"

Strong Answer:

"WACC is the weighted average of cost of equity and after-tax cost of debt, weighted by their proportions in the capital structure.

For cost of equity, I'd use CAPM: $R_e = R_f + \beta \times (R_m - R_f)$. I'd find beta from Bloomberg or FactSet, use the 10-year Treasury as the risk-free rate, and apply a 5-7% equity risk premium based on historical data.

For cost of debt, I'd use the company's current marginal borrowing rate, which I can estimate from recent debt issuances or credit spreads. Then I multiply by $(1 - T_c)$ to reflect the tax shield from interest deductibility.

I'd use the company's target capital structure for the weights, not current book values, because market values and management's long-term capital allocation are more relevant for valuation."

Follow-Up 4: "What are the limitations of a DCF?"

Strong Answer:

"DCF is highly sensitive to assumptions. Small changes in terminal growth rate, WACC, or margin assumptions can swing valuation significantly. This is why we run sensitivity tables and scenario analysis.

It's also backward-looking in some ways because it relies on historical relationships (like beta) and assumes the future resembles the past, which may not hold for disruptive companies or changing industries.

For early-stage companies with negative cash flows or uncertain business models, DCF is less reliable. In those cases, precedent transactions or revenue multiples might be more appropriate.

Finally, DCF assumes rational, efficient markets, but market prices can diverge from intrinsic value due to sentiment, liquidity, or information asymmetries."

Follow-Up 5: "How would this change for a high-growth tech company?"

Strong Answer:

"For high-growth tech companies, I'd extend the projection period to 7-10 years instead of 5 because growth trajectories are less stable and take longer to normalize.

I'd also model revenue more granularly, potentially building bottom-up projections by product line, user growth, or subscription cohorts rather than top-down growth rates.

Margins would likely expand over time as the company scales and achieves operating leverage, so I'd model margin progression explicitly rather than assuming steady-state margins.

For terminal value, I'd be more conservative with the perpetuity growth rate (maybe 2-2.5%) or use a lower exit multiple than current comps because high multiples today might not persist as growth normalizes.

Finally, WACC would be higher due to higher beta, reflecting the business's volatility and risk, which lowers the present value of those distant cash flows."

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Common Mistakes to Avoid

1. Rambling Without Structure

Weak approach: Starting with terminal value, jumping back to free cash flow, mentioning WACC randomly, and losing the logical thread.

Strong approach: Follow a clear sequence: project cash flows, calculate terminal value, discount everything, bridge to equity value. Stick to it.

2. Getting Lost in Details Too Early

Weak approach: "First I'd build a 5-statement model with monthly granularity and model every line item from first principles using driver-based assumptions..."

Strong approach: "I'd project free cash flow for 5 years based on revenue, margin, and capex assumptions. I can go deeper on any of those if helpful."

Let the interviewer pull you into details rather than diving in unsolicited.

3. Forgetting to Bridge to Equity Value

Weak approach: Stopping at enterprise value without explaining how you get to per-share price.

Strong approach: Clearly state you subtract net debt and divide by diluted shares to get implied share price, which you compare to market price.

4. Not Explaining Why We Use WACC

Weak approach: "I discount at WACC" without explaining what WACC represents or why it's appropriate.

Strong approach: "I use WACC because unlevered free cash flow belongs to all investors, so the discount rate should reflect the blended cost of capital to both debt and equity holders."

5. Ignoring Assumptions

Weak approach: Treating DCF like a mechanical formula without acknowledging that assumptions drive everything.

Strong approach: Mentioning that you'd run sensitivity analysis on key drivers like WACC, growth rates, and margins because valuation is highly assumption-dependent.

6. Confusing Levered and Unlevered Metrics

Weak approach: Mixing up which cash flow measure matches which discount rate.

Strong approach: Clearly state "unlevered FCF discounted at WACC gives enterprise value" or "levered FCF discounted at cost of equity gives equity value."

Advanced Tips for Standing Out

1. Mention Sensitivity Analysis

"In practice, I wouldn't rely on a single-point estimate. I'd build sensitivity tables varying WACC and terminal growth rate to show a range of values, and run scenario analysis for bull, base, and bear cases. This gives a valuation range rather than a false precision."

This shows you understand real-world valuation work.

2. Discuss Mid-Year Convention

"Technically, I'd use mid-year discounting rather than end-of-year because cash flows occur throughout the year, not all on December 31st. This increases present value slightly because cash flows are discounted for 0.5 years less on average."

This is a sophisticated detail that impresses without being pedantic.

3. Reference Comparables as a Sanity Check

"After completing the DCF, I'd compare the implied valuation to comparable company multiples and precedent transactions to ensure the output is reasonable. If my DCF suggests 20x EBITDA but comps trade at 10x, I'd revisit my assumptions."

This shows you think about valuation holistically, not just mechanically.

4. Acknowledge the Circular Reference

"One complexity is that WACC depends on the market value of equity and debt, but those values depend on the DCF output, creating a circular reference. In Excel, I'd enable iterative calculations or use a target capital structure to avoid circularity."

This demonstrates technical depth and practical modeling experience.

5. Connect to Investment Thesis

"Ultimately, the DCF tells you what the business is worth based on fundamentals. If the implied value is significantly above market price, that suggests potential upside, but I'd want to understand why the market is mispricing it before concluding it's undervalued. Maybe there are risks I'm not capturing in my model."

This shows investment judgment beyond just running numbers.

Practice Framework

Here's how to master this question over one week:

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When DCF Might Not Be Appropriate

Show sophistication by acknowledging when DCF has limitations:

Financial institutions (banks, insurance companies): Cash flow is not a meaningful metric because lending and borrowing are core operations, not financing activities. Use dividend discount models or P/B multiples instead.

Early-stage companies with negative cash flow: When a company is burning cash and the path to profitability is uncertain, DCF is speculative. Revenue multiples or venture capital methods may be better.

Companies in distress or restructuring: If the business model is fundamentally changing or bankruptcy is possible, historical relationships break down. Asset-based valuation or distressed comparables may be more relevant.

Highly cyclical businesses: Projecting "normal" cash flows is difficult when results swing wildly. Through-the-cycle analysis or sum-of-the-parts may work better.

Mentioning these nuances shows you think critically about when tools apply rather than blindly applying formulas.

Connecting DCF to Other Topics

Understanding DCF connects to many other interview topics:

LBO modeling: LBOs use similar cash flow projections but focus on debt paydown and sponsor returns rather than intrinsic value. The projection mechanics are nearly identical.

Comparable company analysis: DCF is intrinsic valuation; comps are relative valuation. Smart investors use both and reconcile differences to triangulate value.

M&A synergies: When valuing an acquisition, you'd include synergies in your cash flow projections, which increases the DCF value versus standalone valuation.

Exit strategies: In private equity, the exit multiple you assume in terminal value directly impacts sponsor returns and deal attractiveness.

Key Takeaways

Conclusion

"Walk me through a DCF" is one of the most important technical questions you'll face in investment banking interviews. It appears everywhere, from first-round screens to final Superdays with managing directors, and a weak answer can derail your candidacy immediately.

The good news is that this question is completely learnable. Unlike some interview questions that require creativity or market intuition, DCF is pure mechanics combined with clear communication. With focused practice, anyone can master it.

The key is not just memorizing steps but truly understanding why each step exists, what the output means, and how it connects to investment decisions. Strong candidates don't just recite formulas; they explain the logic, acknowledge assumptions, and demonstrate they've built models hands-on.

Start practicing today. Write out the framework. Record yourself. Practice follow-ups. Make the answer automatic so that when the question comes, you can deliver it confidently, clearly, and completely, demonstrating you have both the technical foundation and communication skills to succeed in investment banking.

Your ability to walk through a DCF smoothly in 90 seconds under interview pressure will directly impact whether you get the offer. Make sure you're ready.