What are the two main components of a DCF valuation?

What are the two main components of a DCF valuation?

• A. Present value of the cash flows and the terminal value, both discounted at the WACC
• B. Market multiples and replacement cost
• C. Earnings multiples and book value
• D. Asset value and liquidation value

Answer: (A)

The question tests understanding of what drives a DCF valuation: forecasting future cash flows and capturing value beyond the explicit forecast period. The two main components are the present value of the explicit forecasted cash flows and the terminal value, which represents the value of all cash flows after the forecast horizon. Both are discounted back to today using the discount rate, typically the weighted average cost of capital, to reflect risk and the cost of capital. The explicit cash flows cover near-term performance, while the terminal value accounts for continuing operations and growth beyond the explicit period. The other options describe relative, cost-based, or asset-based valuation methods, which are not how a DCF builds firm value.

The question tests understanding of what drives a DCF valuation: forecasting future cash flows and capturing value beyond the explicit forecast period. The two main components are the present value of the explicit forecasted cash flows and the terminal value, which represents the value of all cash flows after the forecast horizon. Both are discounted back to today using the discount rate, typically the weighted average cost of capital, to reflect risk and the cost of capital. The explicit cash flows cover near-term performance, while the terminal value accounts for continuing operations and growth beyond the explicit period. The other options describe relative, cost-based, or asset-based valuation methods, which are not how a DCF builds firm value.