VCs absolutely do not use DCF for early stage valuations. Projected cash flows have no meaning when you have no revenue today. You would not be taken seriously by even mentioning DCF as a valuation method.
Instead, valuations are more like housing prices in SF. They keep going up because of the market more than anything. Now having said that, here's how investors (not all are the same obviously) think of valuation:
Most early stage VCs target a % of your company they want to own. That % will depend on a few things. For example, for industries that will require significant capital in the future, they may want to own more today. So they think of it as: How much money does the company need to get to the next stage? How much do I want to eventually own based on the potential of the company?
The target ownership is determined mainly by looking at the amount they stand to make if your company is wildly successful vs the size of their fund. Most will like to have the chance to earn their entire fund back with one big winner. They may invest more to get to that ownership level (giving you a higher valuation) if they believe you can get to a big exit.
Most VCs look at the market rate for valuations, and make more of a binary yes/no decision. So, they ask "Do we like this company?", and then say "The market valuation for a company in this industry at this phase is $X." They know that if they don't adhere to the market, and instead only invest at lower pre-money valuations, then they will lose out on most big winners. VCs are under pressure to deploy capital, and would rather overpay for a company that could be a 10X winner than underpay for a company that they don't believe in.
It also is a signal to the market if company A has a pre-money valuation that is below its peers. Some VCs will stay away. It's like if you tried to sell a car for well-below market value. It signals that something is wrong with the car.
Really, this is the one factor that really affects valuation. You may think that having better traction, or an innovative business model will affect your valuation, but it doesn't. At least not directly. Not in some way that affects discount rate or anything. What those things will do is put your company in a position where more VCs will say yes to "Do we like this company?" and "Do we believe this company can get to a big exit?". This will bring you more offers, and that is the biggest factor in valuation.
Here's a way to look at it: Most YC companies immediately have a 25%-50% higher valuation just because they graduated from YC. This is not because these companies have higher cash flow projections than non-YC companies. It's because VCs know that there will be competition to invest in these companies because many have a track record of future success.
Now having said that, you can negotiate pre-money a little based on factors unique to your business that make an exit size bigger than industry norm. That will give you some bump in early stage valuation, but not as much as competition.
4) Future rounds / dilution
The last point is that, as a founder, it's great to have a high valuation. But be careful of having a valuation that's too high or too low. If you're valuation is too high today, during the next round of financing, you put yourself in a position for a down round. This is a bad signal to investors and the market. Earlier investors will likely be diluted more than they'd like, and likely not participate in future rounds.
On the flip side, if you set the valuation too low, and you try to raise a large amount of capital, then you dilute yourself more than you'd like. VCs (and founders!) don't like the founding team to be diluted too much. It makes it tough to raise money later, as investors don't want to put money into a situation where the founders don't have much skin in the game.
So to summarize, valuation isn't set by looking at future cash flows or anything. It's set by what VCs expect to make if you are successful, which sets the market rate for your stage company in your industry. Deviations from that are based slightly on your specific metrics vs others, but mainly valuations change due to competition for investment in your business. If you try to negotiate valuation with a VC, they will likely pull other levers in the term sheet to give them advantages elsewhere.