Finance Questions

Thank you - I really appreciate it.

Yup agree w/above. For more elaboration on why EBIT over Net Income:

When you use Net Income you have used a levered operating metric. It comes after interest on the income statement so it is only available to equity holders.

However, EBIT comes before interest and is therefore available to both equity and debt holders making it unlevered and capital structure independent.

5) they're re same thing, just one works from the bottom up and the other from top down...

I wanted to follow up on #4.

I understand the difference between levered and unlevered beta and how you have to unlever beta then relever it to capture your company's capital structure, but can someone explain WHEN we would use levered and unlevered free cash flow?

Seen the other threads that talk extensively about levered and unlevered beta and how to calculate LCF and UCF, but I would appreciate if anyone could explain when we use LCF and UCF and what the consequence/outcome of each is...

The vault guide uses unlevered FCFs (using EBIT instead of NI) for both WACC (levered beta) and APV (unlevered), so I was wondering when UFC and LCFs are used. Thanks again.

bump.

Anybody? Quick clarification is greatly appreciated.

Think about it this way:

Unlevered free cash flows don't take into account interest or interest effects on tax --> it's the pure cash flow of the firm independent of capital structure, and as such is appropriate for measuring the intrinsic value of the firm (e.g. DCF)

Levered cash flows take out payments to debt holders (interest and interest effect on tax), so the remaining cash flow is the income for equity holders. Therefore, it's a better measure of equity value and returns to equity. Theoretically you can also use LFCF in the DCF, but you would have to use the COE as your discount factor instead of the WACC, to match discount rates and cash flows.

Thanks for the clarification, Valueadded. So using UCF in a DCF gives enterprise value whereas LCF gives equity value - is this correct?

Yes.

To expand a little bit on some previous answers...

You use unlevered free cash flow with unlevered beta to calculate the cost of equity when using the Adjusted Present Value (APV) method of calculating enterprise value.

You use unlevered free cash flow with levered beta to calculate the cost of equity when using the Weighted Average Cost of Capital (WACC) method of calculating enterprise value.

You use levered free cash flow with levered beta to calculate the cost of equity when using the Flow to Equity (FTE) method of calculating equity value.

This shows you another use of levering/unlevering beta.

Using unlevered beta to calculate the cost of equity allows you to assume the firm is an all equity firm, which is what APV does (APV then separately adds back the present value of the debt tax shield to come up with the total enterprise value). To allow you to perhaps understand this more intuitively, it's the same as using levered beta with a D/E ratio of 0. WACC, on the other hand, adjusts the advantages of the debt tax shield into its discount rate and blends the debt/equity value together to come up with the enterprise value.

Also, there are many ways to calculate FCFF, including both the methods that you've listed as well as other methods (such as using cash flow from operating activities). There is no single correct answer.

Thanks, Valueadded for the clarification and Spacemonkey for expanding. Really clear explanation.