Here's a Quick Way to Value Unlevered & Levered Cash Flows
Calculating these cash flows is easier than you think.
Levered cash flows are also known as equity cash flows, because it values just the equity claim in the business. On the other hand, unlevered cash flows are also known as firm cash flows because it values the entire enterprise. I am more accustomed to referring them as equity or firm cash flows thus I will be referring to them in that format for the remainder of the article.
Levered Cash Flow (FCF) Calculator
Equity cash flows are considered as cash flows after debt payments and after making reinvestments needed for future growth. The discount rate used for these cash flows when preparing a DCF model is the cost of equity.
Free Cash Flow to Equity = Net Income - CapEx + Depreciation - Change in Non-Cash Working Capital +(New Debt Issues - Debt Payments)
Value of Unlevered Free Cash Flow
Firm cash flows are prior to any debt payments but after the firm has reinvested earnings to grow its assets. The discount rate used for these cash flows reflects the cost of equity and debt, also known as the weighted average cost of capital (WACC).
Free Cash Flow to Firm = EBIT*(1-tax rate) - CapEx +(Depreciation + Amortization) - Change in Non-Cash Working Capital
In a DCF model, the present value of equity cash flows reflects only the value of equity claims on the firm whereas firm cash flows reflect the value of all claims on the firm.
How to Convert from Firm to Equity Cash Flows
This calculation is very simple. To get from firm value to equity value simply subtract out the market value of all debt and all other non-equity claims in the firm.
Present Value of Debt - Market Value of Debt = Present Value of Equity
Should I use Equity or Firm Cash Flows in My Model?
Both types of cash flows can be used, as it is possible to convert one kind of cash flow to the other. However, the most important part is matching cash flows with their proper discount rate, as a mismatch can lead to an inaccurate valuation.
Thanks for reading, and I hope this article helped you learn something new or refreshed your memory!
Read More About Cash Flow on WSO
- EBITDA Vs. Operating Cash Flow Vs. Free Cash Flow
- Levered Vs. Unlevered Free Cash Flow Difference
- Levered Free Cash Flow Calculation
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Why do you include principal repayments and debt issuance in your calculation of FCF to equity? You're right technically in the sense that cash flows to equity, but I don't think anyone should evaluate businesses in that manner. To me, principal repayments shouldn't be deducted from FCFE because they create equity -- put differently, paying a $10 dividend and repaying $10 of debt creates the same amount of value for equityholders -- while including debt issuance as a source of cash for equityholders doesn't paint an accurate picture of the cash generating ability of a business.
I usually calculate FCFE as: CFO - Maintenance CapEx.
Think of it this way: Would you rather buy a company that generates $100 in cash (pre-financing) and spends $100 to repay debt, or one that generates $0 pre-financing and borrows $100 to pay dividends?
You're absolutely right mrb87, I apologize for this mistake I made, my intention was to write the formula as:
FCFE = Net Income - CapEx - Change in Working Capital + (Principal Repayments - New Borrowings)
My mistake was in subtracting the net new debt issues, earlier that didn't make sense but my purpose was to add in the net borrowing of the firm.
That's not what I was saying; I'm saying CFF shouldn't play a part at all in FCF as a business evaluation tool.
But isn't the debt financing of a firm important considering that equity holders as residual claimants are affected by the debt financing of a company?
I'm not trying to start a debate or anything of that nature, I just want to learn more about calculating these cash flows and understand your perspective.
You got it wrong dude !
FCFF = +Net Income + Non cash Charges (depreciation and amortization) + [Interest Expense x (1-tax rate)] – Fixed Capital Investment (total capital expenditures) – Working Capital Investments
FCFE =
+FCFF - [Interest Expense x (1-tax rate)] + Net Borrowing
I see what you're saying Ayambastik, and I've adjusted my formula above, however I am certain that the formula for FCFF is:
FCFF = EBIT*(1-tax rate) - CapEx + (Depreciation + Amortization) - Change in Non-Cash Working Capital
Very similar formula to what you wrote however I adjusted for taxes by deducting taxes from EBIT, why do you adjust for taxes with the interest payment?
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