I've read two different interview guides (MI & WSO). One says Unlevered cash flow includes interest and the other say it excludes. which one is it?
Unlevered Cash Flow
The short answer is no, unlevered cash flow does not include interest. The name itself is a give-away. "Leverage" is a term that financiers use to indicate the use of debt. The prefix un meaning not.
unlevered FCF simply means looking at a company's cash flow before the effects of debt are taken into account (ie, CF to all the capital providers for a firm).
Semantics aside, how do we arrive at unlevered cash flow?
unlevered free cash flow calculation
Unlevered FCF is what's available to all providers of capital (i.e. debt, equity and hybrid capital). Including interest expense would negate the point of the metric. FCF that nets out the benefit to debt holders is FCF to Equity (CFO - investments in LT capital - debt pay down), so if you want FCFE then yes interest expense would be left in the calc via Net Income to CFO. Where you may be confused is if when you calculate FCF to all providers of capital (FCFF, or essentially Unlevered FCF) you need to adjust the Interest Expense add-back by removing the "tax-sheild" benefit (Interest Expense*(1-tax rate)). The above is applicable to calculating FCF from the Statement of Cash Flows.
Typically Unlevered FCF Calculation
- Operating income + Amortization of nondeductible goodwill: EBITA*(1-tax rate) aka NOPAT
- Add: D&A and other non-cash expenses affecting the above
- Add: Changes in deferred taxes
- Less: Capex and other investments in fixed capital
- Less: Increase in other non-cash working capital
- Arrive at Unlevered FCF
UFCF's "point" is to give an investor an idea of a company's or an asset's ability to pay interest or retire debt and / or pay a dividend or buy back stock to service equity holders. Therefore it wouldn't make much sense to include interest expense in your calculation.
It is important to understand how these concepts come into play in a DCF model. Likewise, to know how concepts such as this can impact the three financial statements. Mastering these subjects takes time and practice. If you are interested in continuing your self study, then follow the link below to get started.