Most explanations of Free Cash Flow stop at a single year: take EBIT, tax-effect it, add back D&A, subtract CapEx and the change in working capital. That formula is correct, but it only answers half the question an interviewer is really asking in a DCF context. The harder, more practical skill is forecasting that same cash flow line five years into the future from a handful of growth and margin assumptions — because a one-period Free Cash Flow calculation on its own can't be discounted into an Enterprise Value. You need a forecast, not a snapshot.
Why a Single-Period FCF Calculation Isn't Enough
If you already know how Unlevered Free Cash Flow differs from Levered Free Cash Flow, or how to back into FCF from a single year's Net Income, you have the formula down. A full DCF valuation asks you to apply that formula consistently across a multi-year projection window, which introduces a new set of problems: where does the revenue growth rate come from, how do margins evolve, and how do CapEx and working capital scale with the business as it grows.
Building the Forecast, Line by Line
The forecast starts with a revenue build: each year's revenue is the prior year's revenue grown by an assumed rate, and it's common (and realistic) for that growth rate to decelerate over the forecast window as a company matures — for example, stepping down from 10% in Year 1 to 5% by Year 5 rather than holding one flat rate for five years. From there, EBITDA is typically modeled as a constant or gradually expanding margin on revenue, D&A and CapEx are modeled as a percentage of revenue (reflecting the ongoing capital intensity of the business), and the increase in Net Working Capital is tied to the year-over-year growth in revenue, since a growing business generally needs to fund more receivables and inventory.
Once EBIT is derived from EBITDA less D&A, the familiar formula takes over: Unlevered FCF = EBIT × (1 - Tax Rate) + D&A - CapEx - Increase in Net Working Capital, applied to every year in the forecast, not just one. The result is a full stream of cash flows — the exact input a DCF needs before it can even begin discounting.
What Interviewers Are Actually Testing
When an interviewer asks you to "build a DCF from scratch," the multi-year forecast is usually the part that separates candidates who have memorized a formula from those who understand how a model actually behaves. Do margins stay flat or expand? Does working capital scale with revenue or stay fixed? Does CapEx outpace D&A (as it does for a growing company reinvesting in the business) or fall below it (as it might for a maturing one)? These are modeling judgment calls, not formula recall.
The Full DCF from Scratch case walks through exactly this kind of five-year build, starting from a revenue base and a full set of operating assumptions, and carries the resulting Unlevered Free Cash Flow stream all the way through the discount rate, the terminal value, and the equity bridge to a per-share value — the complete arc that a single-period FCF calculation only sets up.
Common Pitfalls in a Multi-Year Build
A few mistakes show up repeatedly when candidates build this forecast under interview pressure: holding a single growth rate flat for all five years when the prompt implies deceleration, forgetting that the increase in working capital should scale with the change in revenue rather than the revenue level itself, and mixing up which line items are inputs (assumptions) versus outputs (calculated). Getting the mechanics of the forecast right is what makes every later step of the DCF — the discount rate, the terminal value, the final valuation — actually mean something.