Levered Free Cash Flow Calculation

What do you do with the principle part of an amortizing bond when calculating levered free cash flow?

You have an amortizing bond. The principle part of the amortization payments is not interest, but at the same time this is a required cash payment and thus not available to equity holders.

My textbook says "If there are mandatory repayments of debt, then some analysts utilize levered free cash flow which is the same formula as unlevered free cash flow, but less interest and mandatory principal repayments." However it then gives the formula Unlevered Free Cash Flow + Net Borrowing - Interest x (1 - tax rate). Does this mean if I took out a 50mm loan that levered FCF would increase by $50mm?

Levered Cash Flow Formula and Debt Paydowns

While unlevered free cash flow looks at the funds that are available to all investors, levered free cash flow looks for the cash flow that is available to just equity investors. It is also thought of as cash flow after a firm has met its financial obligations. This includes paying off all mandatory debt payments which would include amortizing bonds or maturity payments.

Levered free cash flow is calculated as Net Income (which already captures interest expense) + Depreciation + Amortization - change in net working capital - capital expenditures - mandatory debt payments.

It is important to note that even if a company is profitable from a net income perspective and positive from an unlevered free cash flow perspective, the company could still have negative levered free cash flow. This could mean that this is a dangerous equity investment since equity holders get paid last in the event of bankruptcy.

Learn more about how to calculate unlevered and levered free cash flow on a detailed thread on WSO.

Read More About Levered Cash Flow on WSO

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Comments (31)

Apr 10, 2012

If you took it out right at the end of the year, therefore getting to skip interest payments on it? Yep. That's the way I learnt it, at least.

Apr 10, 2012

I like to put principal amortisation below "levered FCF" as this is sometimes financed with an equity injection and it makes it easier to see if both lines are in the same section. Also, because of FCF sweeps (if applicable), you'd want to separate the cash interest line from debt amortisation otherwise you'll just see levered FCF of 0.0 (assuming 100% FCF sweep) in your model which isn't very pretty to look at. It really depends on the company and situation you're modelling. My models are always unique for every company, and I always model it in a way which makes sense to me (and which would make sense to anyone else looking at it). There's no point getting caught up in semantics if someone else has to go through your model line by line just to understand what's going on.

Hope that helps brother.

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Apr 10, 2012

Just to add,

In reality, I rarely ever use the term "Levered FCF". Instead, I'd call it something like "FCF before debt service" and "FCF after interest" to make the distinction between the two.

Apr 10, 2012

levered cash flow is just cash flow from op - capex. In some debt investments you look at them to see how much cash you have left before paying down any principal on the debt. In a LBO model you use this number + any cash left from previous period - min cash + any revolver being drawn to be the mandatory debt cash paydown. Hope this clarifies.

Apr 10, 2012
Ricqles:

levered cash flow is just cash flow from op - capex.

Wrong

Ricqles:

In some debt investments you look at them to see how much cash you have left before paying down any principal on the debt.

Ignoring working capital? taxes? interest? Wrong.

Ricqles:

In a LBO model you use this number + any cash left from previous period - min cash + any revolver being drawn to be the mandatory debt cash paydown. Hope this clarifies.

Lol just lol if you think you can draw down on an RCF to repay a pari passu term loan. Just lol.

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Apr 10, 2012
NewGuy:
Ricqles:

In a LBO model you use this number + any cash left from previous period - min cash + any revolver being drawn to be the mandatory debt cash paydown. Hope this clarifies.

Lol just lol if you think you can draw down on an RCF to repay a pari passu term loan. Just lol.

I've seen a few modelling guides who teach this RCF drawdown when cash short on principle . Obviously they don't read intercreds and SFAs. I've never read loan docs from the LSTA but it may be different over there.....don't see why it would be though.

Apr 10, 2012

Indeed those were the good days, but ARE generation is getting fucked with shitty markets and stricter regulation that will bring us two decades of declines, lower pay, and harder work. Life sucks bros.

To add to the above, main reason RCFs won't be utilised to pay back a mandatory amort is because senior secured debt will usually come with a debt service coverage ratio covenant of at least 1.0x, meaning the company needs enough unlevered FCF to fund debt service (interest + mandatory amort). In the event where you'd need to draw down on an RCF to fund the mandatory amort, you will already have blown the covenant which will freeze RCF drawings. They can usually be cured with equity (called equity cures) which will get added to the unlevered FCF number for the covenant test.

Example: company MauFuckinPreftigeUpinThisBiatch has LTM unlevered FCF of 100m, and total debt service for the period is 40mm cash interest + 90mm mandatory amortisation.

The debt service coverage ratio will be 100/(40+90) which is < 1.0x. To cure the event, shareholders will have to fund the extra 30mm via an equity injection. This will count as an equity cure which gets added directly to unlevered FCF, bringing the covenant test for the period to (100+30)/(40+90) = 1.0x
To be honest, I'm not 100% sure what I said about intercreditor agreements is true (assumed so) but I knew there had to be a more concrete technical reason why this doesn't happen, and then I remembered this.

Now if shareholders can't fund the 30mm injection (or simply refuse to coz their equity is so far out of the money), then we got ourselves a special situation.

Apr 11, 2012
NewGuy:

Indeed those were the good days, but ARE generation is getting fucked with shitty markets and stricter regulation that will bring us two decades of declines, lower pay, and harder work. Life sucks bros.

To add to the above, main reason RCFs won't be utilised to pay back a mandatory amort is because senior secured debt will usually come with a debt service coverage ratio covenant of at least 1.0x, meaning the company needs enough unlevered FCF to fund debt service (interest + mandatory amort). In the event where you'd need to draw down on an RCF to fund the mandatory amort, you will already have blown the covenant which will freeze RCF drawings. They can usually be cured with equity (called equity cures) which will get added to the unlevered FCF number for the covenant test.

Example: company MauFuckinPreftigeUpinThisBiatch has LTM unlevered FCF of 100m, and total debt service for the period is 40mm cash interest + 90mm mandatory amortisation.

The debt service coverage ratio will be 100/(40+90) which is < 1.0x. To cure the event, shareholders will have to fund the extra 30mm via an equity injection. This will count as an equity cure which gets added directly to unlevered FCF, bringing the covenant test for the period to (100+30)/(40+90) = 1.0x
To be honest, I'm not 100% sure what I said about intercreditor agreements is true (assumed so) but I knew there had to be a more concrete technical reason why this doesn't happen, and then I remembered this.

Now if shareholders can't fund the 30mm injection (or simply refuse to coz their equity is so far out of the money), then we got ourselves a special situation.

This - and typically your coverage ratio is going to be well north of 1x (and there are also likely going to be covenants about what your leverage ratios are for total funded debt), so you're never really going to get into the situation where someone is trying to draw on a RCF to service other debt. If they were put into that situation they're already fucked as it is.

Apr 11, 2012

Umm I'm pretty sure that Free Cash Flow by definition is unlevered. Where are you getting these formulas?

Apr 11, 2012

Levered FCF does exist. Discount it by the cost of equity to arrive at equity value.

Apr 11, 2012

Sorry, to be clear, I simply mean levered cash flow after debt service - i.e. to be used in an LBO

Apr 11, 2012

The key differentiator is the tax number you pick. For FCFE, I would suggest you always start from Net income. For the EBITDA method you will need to calculate taxes on EBIT which is not always well regarded as a technique.

To sum it up

FCFF: Start from EBITDA
FCFE: Start from PAT

Apr 11, 2012
banker88:

I'm a dumbass

dont take banker88's advice ever.

Apr 11, 2012

The easiest is just looking at Cash Flow from Operations less Capex... Since Cash Flow from Operations starts at Net Income. That is under the context of having a full 3 statement model.

However your model is set-up should dictate how you bridge...

Apr 11, 2012

For the most part, I do not think the modeling tests go into that much depth via modeling what precisely cash taxes are. In reality, the change in deferred assets/liabilities usually encapsulates the impact of various items on cash taxes (change in DTA/DTL associated with depreciation of assets will help reconcile income tax to cash taxes).

Even if you're building out a full fledged three statement, the practice models I have seen don't have you build out a full DTA/DTL schedule unless it's related to NOLs.

For three statement, as the poster said above the easiest is to just move from your CF statement in creating your levered FCF (CFO - CFI is essentially levered FCF). The cash flow from operations will incorporate any necessary adjustments in order for your B/S to balance. For simpler models, it really shouldn't matter because all the formulas you listed will match for a simplistic non 3 statement analysis. I typically use Net Income method you outlined as I build most P&Ls down to Net Income and because it allows you not to worry about adjusting things after tax.

Apr 11, 2012

if you want (for the sake of you getting out of the office) just build in a quick toggle and just ask your associate on monday?

however, to answer your question, i've never seen equity infusions count as part of a levered fcf calc.

Apr 11, 2012

Don't include equity infusion in LFCF calc. Include it in change in cash so total delta is 0 for the year

Apr 11, 2012

LFCF and UFCF are supposed to describe cash the firm is generating through its business. I can't imagine why you'd use debt/equity injections for that calculation. Dukebanker12 got it.

Apr 11, 2012
klieger:

LFCF and UFCF are supposed to describe cash the firm is generating through its business. I can't imagine why you'd use debt/equity injections for that calculation. Dukebanker12 got it.

Yes. I guess I'm confused because in a normal fcf/dcf build I'm used to looking at a business model in the course of its life with fairly steady items YoY. In this case you have enormous capex upfront for construction that you aren't earning on until 4 years out and not earning fully on until about 6 years out. Basically it will calculate as having 0 equity value (and probably pretty close to that in enteprise value as well). Is there any way to work around this or is a dcf just a poor valuation methodology to use for a construction project / something with large upfront costs.

http://pages.stern.nyu.edu/~adamodar/New_Home_Page... - Aswath writes to add inflows from newly issued debt for FCFE. Is this not correct?

Apr 11, 2012

you use net income instead of ebit and the rest stays the same

Apr 11, 2012
eric1025:

you use net income instead of ebit and the rest stays the same

Instead of net income, you can also use EBIT(1-T) as a similar proxy.

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  •  Apr 11, 2012

net income + depreciation - increase in wc - capex +(increase in debt - repayment of debt)

Apr 11, 2012

Agree with WHMD. Most times I've seen levered FCF it has been off EBIT(1-t). A lot of stuff below EBIT is hard to flesh out and normalize, so most just use EBIT(1-t) because it is 'cleaner', ie you know all the non-recurring adjustments have been made to get from GAAP to non-GAAP.

Apr 11, 2012
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