The most common DCF error is projecting growth without charging for it. Every dollar of new revenue needs new factories, inventory, receivables or research. The engine offers two ways to estimate that cost.
Sales-to-capital (default)
The sales-to-capital ratio is how much revenue a dollar of invested capital produces. A ratio of 2.0 means $1 of capital supports $2 of revenue, so growing revenue by $100 costs $50. It is estimated from five years of history as the change in revenue divided by net capital spending, with the Damodaran sector median as a fallback. Higher is more capital-efficient. Software companies run above 3, heavy industry below 1.
Explicit components
Capital expenditure net of depreciation and amortization is net capex, the growth in fixed assets. The change in net working capital is the cash tied up in receivables and inventory as the business grows, net of payables. Each is entered as a percentage of revenue.
Go deeper
- dataDamodaran: Capital expenditures and sales-to-capital by sector
- articleInvestopedia: Net working capital
- articleDamodaran: Estimating growth (lecture notes, packet 2) · The reinvestment rate × return on capital view of growth.