Lesson A1.1 · 1 of 5 · Valuation
DCF model step by step: FCFF, terminal value and an Apple example
A DCF model values a company as the sum of its future free cash flows, brought back to what they are worth today. You forecast the cash flow for a few years, add a terminal value, adjust for net debt and divide by the diluted share count. The answer rests entirely on assumptions, so read it as a range.
Terms in this lesson
- DCF
- Today's value of all the cash a company will produce in the future.
- Free cash flow (FCF)
- The cash left to the company after it pays for its investments.
- WACC
- What the money the company runs on costs it, on average.
- Net debt
- The company's financial debt minus the cash it holds.
What is free cash flow to the firm (FCFF)
In the cash flow lesson you worked out simple free cash flow: operating cash flow minus capital spending. In the fair value lesson you discounted a few future sums. A full DCF model puts the two together, but it starts from a more precise version of cash flow: the cash that belongs to everyone who funds the business, shareholders and lenders alike.
Definition
How is FCFF calculated?
FCFF = EBIT × (1 - tax rate) + depreciation and amortisation - capital expenditure - the increase in working capital.
You start from operating profit (EBIT), tax it as if the company had no debt, add back depreciation and amortisation (a charge that does not leave the bank account that year), then take off spending on buildings and equipment (capex) and any extra cash tied up in stock and receivables. Interest is not deducted: FCFF is the cash flow before lenders are paid, which is why you discount it at the weighted average cost of capital, a rate that includes the cost of debt.
| Apple, financial year 2025 | $m | Where it comes from |
|---|---|---|
| Operating income (EBIT) | 133,050 | income statement |
| - Tax on EBIT at the 15.6% effective rate | -20,769 | $20,719m tax ÷ $132,729m pre-tax profit |
| = Net operating profit after tax (NOPAT) | 112,281 | |
| + Depreciation and amortisation | 11,698 | cash flow statement |
| - Spending on property, plant and equipment | -12,715 | cash flow statement |
| - Working capital (2023-2025 average) | -9,309 | an assumption, see below |
| = Base-year FCFF | 101,955 | about $102.0bn |
Apple’s financial year ended on 27 September 2025. Figures from the Form 10-K annual report; the calculations are ours. Share-based pay ($12,863m) is already deducted in EBIT and we do not add it back: it is a real cost to shareholders, paid through dilution.
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Create a free accountForecasting five years and discounting the cash flows
The model’s assumptions, stated up front: the valuation date is 31 December 2025; FCFF grows by 6% a year for the next five years (Apple’s revenue grew 6.4% in financial year 2025); the discount rate is 9.75%, the weighted average cost of capital worked out in the next lesson. These are working assumptions, not a forecast.
| Year | FCFF, $bn | Discount factor | Value today, $bn |
|---|---|---|---|
| 1 | 108.07 | 0.9112 | 98.47 |
| 2 | 114.56 | 0.8302 | 95.11 |
| 3 | 121.43 | 0.7565 | 91.86 |
| 4 | 128.72 | 0.6893 | 88.72 |
| 5 | 136.44 | 0.6280 | 85.69 |
| Total | 459.84 |
Discount factor = 1 ÷ 1.0975 to the power of the year. Each year is the previous year’s FCFF × 1.06. Our calculations, from unrounded figures.
Terminal value with the Gordon growth model
Definition
How is terminal value calculated?
Terminal value = FCFF in year 6 ÷ (discount rate - long-term growth).
It is the constant-growth (Gordon) formula from the fair value lesson, applied at the end of year 5. It only works if growth is below the discount rate. Damodaran adds a common-sense test: long-term growth has to be reasonable relative to the nominal growth of the economy, because no company can grow faster than the economy it sits in for ever. The model uses 3% a year.
Terminal value = 140.53 ÷ 0.0675 = $2,081.96bn, at the end of year 5.
From company value to value per share
- Enterprise value: $1,767.37bn459.84 (years 1-5) + 1,307.52 (terminal value in today’s money).
- Plus net cash: $54.29bnOn 27 December 2025 Apple held $144.80bn of cash and marketable securities against $90.51bn of borrowings, so its net debt was negative.
- Equity value: $1,821.65bnWhat is left for shareholders once lenders are accounted for.
- Divided by 14,743m shares: $123.5614,681m shares in issue on 16 January 2026, plus 62m for dilution (the gap between the diluted and basic share counts in the quarter to 27 December 2025).
Apple closed at $271.86 on 31 December 2025. The model gives less than half that. This does not say “Apple is overpriced”: it says the price builds in something different from our assumptions, such as faster growth for longer or a lower discount rate. The lesson on valuation scenarios shows what growth the price implies within this model.
| Discount rate | Growth 2% | Growth 3% | Growth 4% |
|---|---|---|---|
| 8.75% | $127.66 | $144.71 | $168.93 |
| 9.75% | $111.36 | $123.56 | $139.99 |
| 10.75% | $98.80 | $107.87 | $119.63 |
Value per share from the same model, changing only the discount rate and long-term growth; FCFF still grows 6% a year in years 1-5. Our calculations.
Real case
The Apple model, as at 31 December 2025
Just two long-run assumptions move the value between $98.80 and $168.93 a share. The model is an exercise in method, not a price target. The analysis page shows Apple’s figures over several years, so you can form your own assumptions.
Lessons are educational. They are not a recommendation to buy or sell. Investing involves risk and you can lose money. Sources: Apple, Form 10-K for the financial year ended 27 September 2025 (operating income $133,050m, pre-tax income $132,729m, income tax $20,719m, depreciation and amortisation $11,698m, share-based compensation $12,863m, payments for property, plant and equipment $12,715m, changes in operating assets and liabilities 2023-2025, net sales $416,161m and $391,035m); Apple, Form 10-Q for the quarter ended 27 December 2025 (cash $45,317m, marketable securities $21,590m and $77,888m, commercial paper $1,997m, term debt $11,827m and $76,685m; 14,681,140 thousand shares at 16 January 2026; 14,748,158 thousand basic and 14,810,356 thousand diluted shares in the quarter); closing price on 31 December 2025: Yahoo Finance; Aswath Damodaran (NYU Stern), lecture notes on FCFF and the stable growth model. The assumptions (growth, discount rate, terminal value) and the calculations are ours.