I've seen textbook definitions of levered and unlevered FCF but I'm not sure I really understand it intuitively. What's the difference between levered and unlevered FCF (formula and philosophy). Why does it matter? Which should be used in a DCF?
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Leverage just means debt, unlevered FCF is the FCF not accounting for debt structure/capital structure. You would do this in a DCF if you would like to compare companies with different capital structures, ie the value of the business/operations as opposed to how much of their cash is coming from raised capital.
Either can be used in a DCF, depending on if you are trying to solve for equity value or enterprise value. An unlevered cash flow (used in a DCF to find enterprise value) is a cash flow that is attributable to all investors in a company (both debt and equity holders) bc it is calculated before subtracting mandatory debt repayments. A levered cash flow (used in a DCF to find equity value) is a cash flow that is attributable only to equity investors in a company bc it is calculated after subtracting mandatory debt repayments.
UFCF = EBIAT + non cash expenses - increases in net working capital - CapEx
LFCF = Net income + non cash expenses - increases in net working capital - CapEx - mandatory debt repayments
As the formulas indicate, the biggest difference between the two is that you must subtract interest expense and mandatory debt repayments when calculating levered free cash flow.
This is old, but nevertheless for the sake of having threads with correct information - I believe you forgot to add D&A there.
I would summarize for UCFC as: NOPAT+ D&A and other non-cash adjustments +/- Change in WC – Capex.
D&A is a non cash expense
This is pretty on point, but I’ll add that on levered DCF the discount rate is just the cost of equity
Unlevered = debt unpaid Levered = debt paid
and interest
levered = FCF available to equity holders b/c this is whats left after debt holders have been paid -> you start at NI instead of NOPAT / EBIAT so you take into account interest expenses
Unlevered = FCF available to all capital holders. Starting point is EBIAT, notice how this doesn't take into account interest expenses yet
A company sells goods or a service and makes some cash. But not all that cash is available to use, they have to account for all of their little expenses to keep selling that good or service. The cash left over is what we call their “profit” or cash to do whatever else they need to run or grow the business.
Cash flow is describing the actual dollars coming in and out of the business.
Unlevered free cash flow, is the amount of cash we have before we have to pay back anyone who has invested outside capital into our company. This is cash that is available to all investors, both who has issued debt (before interest payments/income) and those who have issued equity (preferred stock and common stockholders who only get paid, after we pay off our debts).
Levered free cash flow, is cash that is available only to our equity investors, since we have taken out the cash necessary to pay off our debts.
Can you now explain it like I am three and am going into a top feeder preschool?
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