How do you conduct a DCF sensitivity analysis and which inputs matter most?

Sensitivity analysis is essential because DCF valuations are highly dependent on a few key assumptions. Small changes in these inputs can dramatically shift the implied value.

The most impactful DCF inputs:

1. WACC (discount rate) — A 1% change in WACC can shift the value by 15-25%
2. Terminal growth rate — Drives the terminal value, which often represents 60-80% of total DCF value
3. Revenue growth rate — Especially in the explicit forecast period
4. Operating margins — Affect free cash flow generation
5. Capital expenditure assumptions — Affect conversion of earnings to free cash flow

One-way sensitivity table:

Vary one input at a time while holding others constant.

Example — Apex Dynamics DCF (base case: $52/share):

A 1% increase in WACC drops the value by $8 (15%).

Two-way sensitivity table (data table):

Vary two inputs simultaneously — typically WACC vs. terminal growth rate.

Why terminal value dominates:

Terminal value = FCF_n+1 / (WACC - g)

As g approaches WACC, the denominator shrinks and terminal value explodes. This is why a 0.5% change in terminal growth can have an outsized impact.

Scenario analysis (complements sensitivity):

Instead of varying one input mechanically, build coherent narratives:

• Bull case: Accelerating growth (8% revenue), expanding margins (25%), lower WACC (9%) → $72/share
• Base case: Moderate growth (5%), stable margins (22%), base WACC (10%) → $52/share
• Bear case: Stagnant growth (2%), margin compression (18%), higher WACC (11.5%) → $32/share

Best practices:

• Always present a range, never a single point estimate
• Focus sensitivity on the 2-3 inputs with the most impact
• Check if the implied terminal multiple (EV/EBITDA at exit) is reasonable
• Compare DCF results to market multiples as a sanity check

Exam tip: CFA Level II may ask you to calculate how a DCF value changes given a specific change in WACC or terminal growth. Practice the terminal value formula and understand why small changes in the denominator create large value swings.

Dive deeper into DCF modeling on AcadiFi's CFA Level II course.