A discounted cash flow (DCF) model produces a single Enterprise Value number, but that number is only as good as the assumptions behind it. Two inputs do most of the work in determining that value: the discount rate (WACC) and the terminal growth rate. Because both are estimates rather than observable facts, no experienced analyst presents a DCF as one precise figure — they present it as a range, built using sensitivity analysis.
What Sensitivity Analysis Actually Tests
Sensitivity analysis means recalculating Enterprise Value multiple times while systematically varying one or more inputs, then observing how much the output changes. In a DCF, the two most common variables to test are WACC and the terminal growth rate (g), because together they determine the Terminal Value — which typically accounts for 60–80% of total Enterprise Value. A small change in either input can move the valuation by a meaningful amount, which is exactly why interviewers ask candidates to build and interpret these tables.
Why WACC Usually Matters More Than Terminal Growth
It's tempting to assume WACC and terminal growth affect value symmetrically, since both appear in the Terminal Value formula: Terminal Value = FCF × (1 + g) / (WACC − g). But WACC actually has a double effect. It shrinks the (WACC − g) denominator when calculating Terminal Value, and then it shrinks the value again when discounting that Terminal Value back to the present via (1 + WACC)^n. The terminal growth rate, by contrast, only affects the first channel. That asymmetry is why, in practice, Enterprise Value tends to be considerably more sensitive to WACC than to terminal growth — often by a factor of two or more, depending on the discount period and growth assumptions used.
You can see this worked through with real numbers in Case 46: Sensitivity Analysis — WACC vs. Terminal Growth Rate, which builds a full 3x3 grid of Enterprise Value outcomes and measures exactly how much each assumption swings the result.
Where Sensitivity Analysis Fits in a DCF
Sensitivity analysis isn't a separate exercise from the DCF itself — it's built directly on top of the same mechanics. If you haven't yet built a full model, it helps to first work through Full DCF from Scratch, which walks through the five-year projection, discounting, and terminal value calculation that a sensitivity table then stress-tests. Understanding how WACC itself is constructed — and how it responds to leverage — is also useful background; see WACC: The Building Blocks and WACC with Leverage. The terminal growth assumption itself is covered in Terminal Value: Gordon Growth.
Why Interviewers Ask About This
Interviewers ask candidates to reason through sensitivity analysis because it tests something beyond formula recall: whether you understand which assumptions are doing the heavy lifting in a valuation, and whether you can communicate uncertainty honestly. A candidate who presents a DCF as a single confident number, without acknowledging how much that number depends on WACC and growth assumptions, is signaling a shallower understanding of the model than one who can say, "our base case is $X, but it's a range of $Y to $Z depending on how you set WACC."