Discounted Cash Flow (DCF) analysis asks a deceptively simple question: what is the present value of all the cash a business will generate from now until the end of time? Despite its apparent simplicity, DCF analysis done well is arguably the most rigorous approach to equity valuation -- and done poorly, it's a machine for producing any number you want.

This primer focuses on applying DCF to Indian listed companies, with attention to the specific adjustments needed for local market conditions.

The DCF Formula

The intrinsic value of a company equals the sum of its future free cash flows (FCF), discounted back to the present at a rate that reflects the risk of achieving those cash flows:

Intrinsic Value =  [FCFt / (1 + WACC)^t] + Terminal Value / (1 + WACC)^n

Where:

  • FCFt = Free Cash Flow in period t (Operating Cash Flow minus Capex)
  • WACC = Weighted Average Cost of Capital (the discount rate)
  • Terminal Value = Value of all cash flows beyond the explicit forecast period
  • n = length of explicit forecast period (typically 5-10 years)

India-Specific Adjustments

1. WACC calculation for Indian companies:

  • Risk-free rate: Use 10-year Indian Government Security (G-Sec) yield, not US 10-year Treasury.
  • Equity risk premium for India: Research suggests 5-7% (higher than US due to emerging market risk) -- use 6% as a reasonable central estimate.
  • Beta: Use 2-year weekly betas calculated against Nifty 500, not international indices.
  • Cost of debt: Use the company's actual weighted average cost of borrowing, not a benchmark rate. Refer to the notes to financial statements in the Annual Report.

2. Working capital treatment: Indian companies in retail, distribution, and trading often have significant working capital cycles. Model changes in working capital explicitly rather than embedding them in a flat FCF margin.

3. Capex intensity cycles: Indian infrastructure, cement, and capital goods companies go through lumpy capex cycles. A 3-5 year average capex is more representative than a single-year figure.

4. Tax rates: Indian corporate tax rate (post-2019 reform) is 25.17% for domestic companies under the new regime. Deferred tax liabilities/assets can create significant differences between reported PAT and cash taxes paid.

Terminal Value: The Most Important (and Fragile) Number

In most DCF models, 60-80% of the intrinsic value comes from the terminal value. This makes the terminal growth rate assumption critically important. For Indian companies:

  • Use a terminal growth rate of 5-7% for businesses with durable competitive advantages in growing Indian sectors.
  • Use 3-5% for stable, mature businesses.
  • Terminal growth rate should never exceed the long-term nominal GDP growth expectation for India (approximately 10-11% nominal at 7% real + 3-4% inflation).

Common DCF Mistakes to Avoid

  • Using USD risk-free rates for INR-denominated cash flows
  • Projecting revenue growth of 20%+ for 10 years without competitive moat justification
  • Ignoring dilution from ESOPs and convertible instruments
  • Using reported PAT instead of owner earnings (FCF) as the cash flow base
  • Forgetting to add cash and subtract debt to convert enterprise value to equity value

CWOS's Research Terminal automatically computes indicative DCF ranges for listed companies using consensus analyst estimates for near-term FCF and calibrated assumptions for WACC and terminal growth. These are starting points for analysis, not final valuations -- every DCF model benefits from the judgment of someone who understands the specific business.