Why do valuations focus on the core operations of a business?
This might seem pretty basic but I am still trying to wrap my head this. In a DCF, for example, we use unlevered free cash flow. UFCF normalizes for different capital structure, different D&A schedules, different tax rates, and (I guess this one is depending on the person doing the valuation/calculating UFCF) non-recurring items. Why though? What's the point? If anyone knows the reasoning on this, I'd love to hear it.
You can't compare companies with different leverage ratios, coverage ratios, working capital requirements, cap ex purchases, litigation fees, etc.
You can compare them more closely if you take these confounding factors out and only look at core business operations. By looking at specific capital structure-neutral cash flows attributable to the business we're able to actually see what each company is making or losing, in cash, and in a comparable format.
If that's still confusing consider Company A with 150 in earnings and 50 in interest expense, and Company B with 175 in earnings and 25 in interest expense. B pays out more money to shareholders but both have an EBIT of 200 (for the purposes of this example), and so the FCF would be the same given the same D&A, cap ex, WC, etc.
FCF is concerned with the amount of money a company produces before there is any payout to any type of investor, debt, equity, or otherwise.
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