Treatment of Interest in FCF/UFCF/LFCF
Hello, I have been learning technicals from the BIWS course and have become confused about FCF vs UFCF and LFCF and their respective treatment of interest payments. In BIWS, they say you should calculate FCF using the following equation:
FCF = CFO - CapEx (however CFO should be adjusted for net interest expense, preferred dividends, lease payments etc if it isn't already)
However, when I search online (and ask ChatGPT, lol) they differ in whether interest payments should be deducted from FCF. This is also confusing me on whether FCF should be paired with Equity Value or Enterprise Value in multiples.
I would appreciate any help - thank you in advance.
Hi!
The definition can vary a bit. But let me provide some input with regards to valuation.
UFCF (or FCFF) for the purpose of conducting a DCF assumes that the company is unlevered, i.e has no debt and therefore no interest payments to take into account for; this means that EBIT = EBT. Deduct the tax expense based on this and adjust for CF affecting items (add-back of D&A, delta NWC and deduct capex).
For LFCF (or FCFE), used in equity valuations and LBOs, the main difference is that you will need to deduct the interest expense from UFCF and add corresponding tax savings (since interest expenses will lower your EBT), or in other words; interest expense net of tax.
For dividends, I would exclude them in both calcs. UFCF is cap structure neutral, and LFCF basically answers the question, in simple terms, “how much cash flow do we have left and can pay out as dividends”. (not taking into account mandatory debt repayments etc)
Hope this is of any help!
… realised I missed your query in how it relates to multiples.
I would recommend keeping it to EV multiples. You wanna keep it simple when spreading comps, keep it to EV multiples and make a simplification of “FCF”. I.e define FCF* as EBITDA - Capex for your TargetCo and it’s comps (remember to footnote whatever definition you go with).
*Include delta NWC if you are prudent with your comps and/or if it’s a non-negligible part of the industry (forward-looking estimates of NWC can be a bit iffy depending on ER coverage). But generally skip taxes since it can vary widely from geographies, NOLs etc.
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