Six parts of groundwork. One payoff. Let’s calculate what Maple Ridge Manufacturing is actually worth.
Over the last six posts, we built every input a DCF model needs. We defined free cash flow in Part 1. We covered the time value of money in Part 2. We walked through the business in Part 3. We calculated Maple Ridge’s FCFF — Free Cash Flow to the Firm, the actual cash the business generates after paying for operations and reinvestment — in Part 4: $32.5 million per year. In Part 5, we derived a sustainable growth rate of 3.3% per year and a reinvestment rate of 13.3% — meaning Maple Ridge keeps about 13 cents of every dollar it earns to fund future growth and returns the rest. In Part 6, we built the WACC — Weighted Average Cost of Capital, the discount rate that reflects the risk of putting money into this business — at 7.8%.
We now have everything. This is the payoff post. We run the full calculation.
Step 1: Project Five Years of Free Cash Flow
The first step is simple. We take the FCFF base of $32.5M and grow it at 3.3% per year for five years. Each year’s cash flow is the previous year multiplied by 1.033.
Year 1: $32.5M × 1.033 = $33.6M
Year 2: $32.5M × 1.033² = $34.7M
Year 3: $32.5M × 1.033³ = $35.8M
Year 4: $32.5M × 1.033⁴ = $37.0M
Year 5: $32.5M × 1.033⁵ = $38.2M
These are the raw projections — what Maple Ridge is expected to generate in each of the next five years. But a dollar received in year five is not worth the same as a dollar today. We have to account for that.
Step 2: Discount Each Year Back to Present Value
This is where WACC does its work. We divide each year’s projected cash flow by 1.078 raised to the power of that year. That converts future dollars into today’s dollars — what each cash flow is worth right now, given risk and the time value of money.
Discount factor is what we call 1.078 raised to the relevant power. It grows larger each year, which is why more distant cash flows shrink the most.
Year 1: $33.6M ÷ 1.078 = $31.2M
Year 2: $34.7M ÷ 1.078² = $29.9M
Year 3: $35.8M ÷ 1.078³ = $28.6M
Year 4: $37.0M ÷ 1.078⁴ = $27.4M
Year 5: $38.2M ÷ 1.078⁵ = $26.3M
Notice the pattern. Even though the raw cash flows grow each year — from $33.6M to $38.2M — the present values shrink from year to year. The discount rate (7.8%) is bigger than the growth rate (3.3%), so time erodes value faster than growth creates it. That relationship is not unusual. It’s how most stable, mature businesses work.
Add the five present values together:
Total PV of 5-Year FCFFs = $31.2M + $29.9M + $28.6M + $27.4M + $26.3M
= $143.4M
This $143.4M is the present value of everything Maple Ridge will generate in the next five years. But a business doesn’t stop operating in year five.
Step 3: Terminal Value — Everything Beyond Year Five
Most of Maple Ridge’s value isn’t in years one through five. It’s in the years beyond that — every year the business keeps running, generating cash, compounding. We can’t project those years individually. Instead, we capture them all in a single number called the terminal value.
Terminal value is the present value today of all the cash flows a business will generate after the projection period ends — in this case, from year six onward, forever. It sounds abstract, but the math is clean.
We use a formula called the Gordon Growth Model, named after economist Myron Gordon. It says: if a business generates a cash flow that grows at a constant rate forever, the value of that stream today is the next year’s cash flow divided by the discount rate minus the growth rate.
First, we choose a terminal growth rate. This is the rate at which we assume Maple Ridge’s cash flows grow forever — long past year five. We use approximately 2.5%, roughly equal to long-run nominal GDP growth. The logic: a mature company cannot grow faster than the overall economy forever. If it did, it would eventually become the entire economy. So we anchor the terminal growth rate to something modest and realistic — roughly as fast as the economy, no faster, no slower.
Terminal FCFF = Year 5 FCFF × 1.025
= $38.2M × 1.025
= $39.2M
Now apply the Gordon Growth Model:
Terminal Value = Terminal FCFF ÷ (WACC − Terminal Growth Rate)
= $39.2M ÷ (7.8% − 2.5%)
= $39.2M ÷ 5.3%
= $739.6M
A word on that denominator. The gap between WACC and the terminal growth rate — 5.3% in this case — acts like a lever. A smaller gap produces a much larger terminal value. A larger gap shrinks it. This is why terminal value is sensitive to your assumptions: shave half a percent off your WACC or add half a percent to your terminal growth rate, and the number moves substantially. We’ll come back to this in the section on what the model tells you (and doesn’t).
That $739.6M is the terminal value as of the end of year five. We still need to bring it back to today. We discount it just like the annual cash flows — by dividing by 1.078 raised to the fifth power:
PV of Terminal Value = $739.6M ÷ 1.078⁵
= $739.6M ÷ 1.459
= $507.7M
Step 4: Enterprise Value — Adding the Pieces
Enterprise value is the total value of the business — not just the shares, but everything. It belongs to all the capital providers: shareholders and lenders alike. We arrive at it by adding the present value of the five-year cash flows to the present value of the terminal value.
Enterprise Value = PV of 5-Year FCFFs + PV of Terminal Value
= $143.4M + $507.7M
= $651.1M
Notice something important about those two numbers. The terminal value alone ($507.7M) accounts for about 78% of the total enterprise value. The five years we projected so carefully contribute only 22%.
This surprises a lot of people when they first see it. But it makes sense. You are valuing a business that will operate for decades, not five years. The first five years are a close-up view. The terminal value captures the remaining decades. The math correctly reflects the fact that most of a business’s value lies in the long run, not the next handful of years.
Step 5: The Equity Bridge — From Enterprise Value to Shareholder Value
Enterprise value is the value of the whole business. But you, as a potential shareholder, don’t own the whole business. Lenders have a prior claim — they get paid before shareholders, and if the company were liquidated today, lenders would be paid first. To find what the shares are actually worth, we have to subtract what belongs to lenders.
This calculation is called the equity bridge. It crosses you from enterprise value — the whole pie — to equity value — your slice.
The number we subtract is called net debt. Net debt is total debt minus cash. We subtract cash because it’s already sitting on the balance sheet — the company could use it to pay off debt right now, today, immediately. Cash offsets debt, dollar for dollar.
Total Debt (from Part 5) = $45M
Cash on Balance Sheet = $12M
Maple Ridge holds $12 million in cash. This is a new detail we haven’t used before, but it comes directly from the balance sheet. That $12M sits there as a liquid asset, immediately available. It reduces the effective burden of the $45M in debt.
Net Debt = Total Debt − Cash
= $45M − $12M
= $33M
Now subtract net debt from enterprise value:
Equity Value = Enterprise Value − Net Debt
= $651.1M − $33M
= $618.1M
$618.1M is the value of everything that belongs to shareholders. Divide that by the number of shares, and you get the intrinsic value per share.
Step 6: Intrinsic Value Per Share
From Part 6, we know Maple Ridge has 10 million shares outstanding.
Intrinsic Value per Share = Equity Value ÷ Shares Outstanding
= $618.1M ÷ 10M
= $61.81 per share
Maple Ridge Manufacturing’s intrinsic value, based on a disciplined DCF analysis using all the inputs we’ve built across this series, is approximately $61.81 per share.
Step 7: Margin of Safety
Maple Ridge is currently trading at $42 per share.
Margin of safety is the gap between intrinsic value and the current market price, expressed as a percentage of intrinsic value. It’s the buffer — the room for error between our estimate and what we’d actually pay.
Margin of Safety = (Intrinsic Value − Current Price) ÷ Intrinsic Value
= ($61.81 − $42.00) ÷ $61.81
= $19.81 ÷ $61.81
= 32%
At $42 per share, Maple Ridge is trading 32% below what our model says it’s worth.
That 32% is doing real work. It means we could be off on our growth assumptions, or our WACC, or our terminal growth rate — and we could be off by quite a bit — and we’d still likely be buying at a fair price. If the true intrinsic value turned out to be $52 instead of $61.81, we’d still be paying only $42. If it turned out to be $48, we’d still be close to right. The margin of safety isn’t a bonus feature. It’s the mechanism that converts a disciplined estimate into a sound investment decision.
What the Model Tells You (and What It Doesn’t)
This is important. The model does not produce a fact. It produces a disciplined estimate.
Every input we used — the growth rate, the reinvestment rate, the WACC, the terminal growth rate — is a reasonable judgment, not a certainty. Companies grow faster or slower than we expect. Interest rates move, and WACC moves with them. A competitor emerges. A product line weakens. These things happen.
The model isn’t designed to eliminate those uncertainties. It’s designed to be transparent about your assumptions so you can stress-test them. If WACC rises to 9%, what happens to intrinsic value? If growth is 2% instead of 3.3%? If the terminal growth rate is 2% instead of 2.5%? You can run each scenario in minutes and see how much it moves the answer.
The goal is not to be precise. The goal is to be approximately right in a disciplined way.
A stock trading at a 32% discount to a carefully constructed, transparent, assumption-based estimate is meaningfully different from a stock trading at fair value or above it. The margin of safety is what creates that difference. It is not a guarantee. It is a rational basis for confidence.
The One-Sentence Summary
When you project five years of free cash flows, discount them back at WACC, add a terminal value for everything beyond year five, subtract net debt, and divide by shares outstanding, you arrive at an intrinsic value per share — and comparing that number to the current market price tells you how large a margin of safety the market is currently offering you.
— Jim