DCF Valuation: Step-by-Step Guide for Indian Businesses
DCF valuation is the most misused and least understood tool in Indian corporate finance. Bankers use it to justify predetermined conclusions. Founders use it to support unrealistic multiples. Here is the methodologically correct version — with India-specific adjustments for WACC, terminal value, and working capital.
The DCF Framework: Five Steps
- Project Free Cash Flows (FCF) for 5–10 years
- Calculate WACC (the discount rate)
- Calculate Terminal Value (value beyond the projection period)
- Discount all cash flows to present value
- Build a sensitivity table (WACC × terminal growth rate)
Step 1: Free Cash Flow — What You're Actually Projecting
Free Cash Flow to Firm (FCFF) is the cash available to all capital providers (debt and equity) after reinvestment needs:
FCFF = EBIT × (1 – Tax Rate) + D&A – Capex – ΔWorking Capital
The most common error in Indian SME DCFs: using EBITDA as a proxy for cash flow without accounting for working capital intensity.
| Item | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
|---|---|---|---|---|---|
| Revenue (₹ Cr) | 50 | 65 | 82 | 100 | 118 |
| EBITDA (18% margin) | 9.0 | 11.7 | 14.8 | 18.0 | 21.2 |
| EBIT (after D&A ₹2Cr/yr) | 7.0 | 9.7 | 12.8 | 16.0 | 19.2 |
| NOPAT (25% tax) | 5.25 | 7.28 | 9.6 | 12.0 | 14.4 |
| Add: D&A | 2.0 | 2.0 | 2.0 | 2.0 | 2.0 |
| Less: Capex | 3.5 | 2.5 | 2.5 | 3.0 | 3.0 |
| Less: ΔWorking Capital | 1.8 | 2.3 | 2.9 | 3.5 | 4.2 |
| FCFF | 1.95 | 4.48 | 6.2 | 7.5 | 9.2 |
Step 2: WACC Calculation for Indian Businesses
WACC = (E/V × Ke) + (D/V × Kd × (1 – Tax Rate))
| Component | India 2026 | Source |
|---|---|---|
| Risk-Free Rate | 6.85–7.0% | 10-year G-Sec yield |
| Equity Risk Premium (ERP) | 6.0–8.0% | Damodaran India ERP estimate |
| Beta (sector-adjusted) | 0.8–1.4 | NSE sector beta |
| Size Premium (SME) | 2.0–4.0% | Additional risk for illiquidity |
| Cost of Equity (Ke) | 13.5–17.5% | CAPM + size premium |
| Cost of Debt (Kd, post-tax) | 7.5–9.0% | Bank lending rate × (1–0.25) |
| Typical WACC Range | 12–16% | — |
Step 3: Terminal Value — The Most Sensitive Input
Terminal Value typically represents 60–75% of the total enterprise value. Two methods:
- Gordon Growth Model: TV = FCFF(n+1) / (WACC – g), where g = perpetuity growth rate
- Exit Multiple Method: TV = EBITDA(n) × EV/EBITDA multiple
India-specific guidance on g: Use 4–5% as a maximum sustainable perpetuity growth rate (India's nominal GDP growth ≈ 10–11%; assume company converges to half of that in perpetuity). Using 7–8% g inflates value by 40–60% and is unjustifiable for most businesses.
Step 4: Sensitivity Table — Always Build This
Enterprise value varies enormously with WACC and terminal growth assumptions:
| WACC \ g | 3% | 4% | 5% | 6% |
|---|---|---|---|---|
| 12% | ₹82 Cr | ₹96 Cr | ₹115 Cr | ₹142 Cr |
| 13% | ₹71 Cr | ₹81 Cr | ₹95 Cr | ₹114 Cr |
| 14% | ₹62 Cr | ₹70 Cr | ₹80 Cr | ₹94 Cr |
| 15% | ₹55 Cr | ₹61 Cr | ₹69 Cr | ₹79 Cr |
| 16% | ₹49 Cr | ₹54 Cr | ₹60 Cr | ₹68 Cr |
This range of ₹49–₹142 Cr illustrates why "DCF says X" is meaningless without disclosing assumptions. Always present a sensitivity table.
Common Mistakes in Indian SME Valuations
- Promoter salary normalisation: Owner-run businesses often pay below-market promoter salaries to show higher EBITDA. Normalise to market rate before projecting
- Working capital ignored: Indian SMEs with 45–90 day debtor days consume significant cash. Model working capital as % of revenue
- Tax holiday periods: For new manufacturing units, MAT/tax holidays change effective tax rate — model year by year
- ESOP dilution: Startup DCFs must account for ESOP pool dilution in equity value per share calculation