Module 7 · DCF Part II: Scenarios & Sensitivity Advanced

A single DCF number is precisely wrong. This module turns Module 6's point estimate into a defensible range — and teaches the reverse DCF, the most practical advanced technique in the course.

The point-estimate fallacy

Module 6 produced $41.38 to the cent. That precision is seductive and misleading. The output rested on a dozen assumptions — growth, margins, WACC, terminal rate — each a judgement call. Change any one and the “answer” moves. The professional mindset is: my DCF is precisely wrong; the useful thing is the range. So we stop hunting for one number and start mapping the neighbourhood.

Scenario design: bear, base, bull

Build three internally consistent stories. Take Northbridge's base case (8% growth, 2.5% terminal, 8.35% WACC → $41.38) and flex it:

Notice each case is coherent: the bear pairs slower growth with a lower terminal rate and a higher discount rate (more risk), the bull the reverse. Then probability-weight them — say 25% / 50% / 25% — for a single, honest expected value: 0.25 × 28 + 0.50 × 41.38 + 0.25 × 60 ≈ $42.7. This is exactly how sell-side analysts produce divergent price targets from the same model — same machine, different beliefs.

Two-way sensitivity tables

Scenarios flex several inputs at once. A sensitivity table isolates the two that matter most — WACC and terminal growth — and shows the value across a grid. Here's Northbridge's DCF value per share:

Read it as “my value lives in this neighbourhood — roughly $35 to $51 depending on two defensible inputs.” A grid like this takes two minutes in a spreadsheet and is worth more than any single number you could put in its place.

The reverse DCF

This is the single most practical advanced technique in the course. Instead of forecasting growth to get a value, take the market price as given and solve for the growth rate it implies. Then ask one question: is that plausible?

Suppose a beloved growth stock trades at a price that, run backwards through the DCF, implies 35% annual free-cash-flow growth for five years — while the company has actually grown FCF around 2% a year. The market is pricing near-perfection. You don't need to forecast anything; you just have to judge whether 35% is believable. Usually the question answers itself.

Common DCF sins

• Terminal growth ≥ WACC. Breaks the perpetuity formula and implies infinite value. Keep terminal growth safely below WACC — a spread of at least three points.
• Terminal growth > long-run GDP. A firm can't outgrow the whole economy forever, or it becomes the economy. Keep terminal growth near 2–3%.
• Hockey-stick margins. Assuming margins leap to record highs and stay there.
• Ignoring dilution. Forgetting that share count creeps up from stock compensation.
• Double-counting cash. Adding cash to the DCF value when it's already inside the cash flows.

The 12-point sanity checklist

Before trusting any DCF, run down: (1) is terminal growth < WACC? (2) is terminal growth ≤ GDP? (3) does growth fade sensibly? (4) are margins realistic? (5) is the WACC defensible? (6) is beta reasonable? (7) is dilution included? (8) is net debt correct? (9) is TV% of EV acknowledged? (10) does the base FCF represent a normal year? (11) have you built a range, not a point? (12) does a reverse DCF sanity-check the price? Any one of these failing is enough to throw the valuation out.