Levered vs. Unlevered Free Cash Flow Difference

usually i know unlevered FCF's are used for DCFs. but why do we use unlevered FCFs instead for DCF's and when are you supposed to use levered FCFs?

What is Free Cash Flow?

Free cash flow is a measure of how much money is available to investors through the operations of the business after accounting for expenses of the business such as operational expenses and capital expenditures.

Why do we add back Depreciation and Amortization to Free Cash Flow?

Depreciation and amortization are non-cash expenses - these are instead accounting expenses that recognize the cost of PP&E and intangible assets over time.

Why do we subtract the change in net working capital?

Net working capital (NWC) is calcuated as current assets - current liabilities. When examining the changes in NWC, if current assets are rising - the company is investing money in assets such as inventory. These are cash expenses that are not being captured on the income statement in operational expenses. If current liabilities are rising then the company is "gaining cash" in the sense that it has not yet paid for something that it will in the future. These might be things such as wages payable - which is being accounted for as an expense on the IS but has not yet been paid.

What is Unlevered Free Cash Flow? (Free Cash Flow to the Firm)

Typically when someone is refering to free cash flow, they are refering to unlevered free cash flow which is the cash flow available to all investors, both debt and equity. When performing a discounted cash flow with unlevered free cash flow - you will calculate the enterprise value.

Free cash flow is calculated as EBIT (or operating income) * (1 - tax rate) + Depreciation + Amortization - change in net working capital - capital expenditures.

What is Levered Free Cash Flow? (Free Cash Flow to Equity)

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. When performing a discounted cash flow with levered free cash flow - you will calculate the equity value.

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

Even if a company is profitable from a net income perspective and postive 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.

How to discount levered and unlevered free cash flow?

When performing a discounted cash flow analysis on unlevered free cash flow, you are examining the cash flow available to the entire capital structure - debt holders, equity holders, and preferred equity investors - and therefore you need to use the weighted average cost of capital which looks at the costs of capital across the capital structure.

When performing a discounted cash flow analysis on levered free cash flow, you are examining the cash flow available to equity investors and should just be using the cost of equity - or the capital asset pricing model (CAPM) to discount cash flows.

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Comments (122)

Sep 28, 2010 - 9:08pm

When trying to get equity value, should you use levered free cash flows and discount with cost of equity or simply calculate enterprise value the normal way and then subtract net debt to get equity value. What is the proper way of how one should do this? thanks

Sep 29, 2010 - 12:01am

When trying to get equity value you use fcff (unlevered fcf) and discount with wacc to get enteprise value, then subtract any other claims (net debt, noncontrolling, preffered) to get equity. or you can calculate fcfe (levered fcf) and discount with cost of equity to get market value of equity.

somebody correct me if i'm wrong here.. i always thought that fcff would be levered fcf because it includes cash that debtholders have a claim on... or am i just confusing myself with the terminology?

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Best Response
Sep 29, 2010 - 12:24am

Unlevered FCF's are generally used by investment bankers while Levered FCF (otherwise known as Free Cash Flows to Equity) are used more by private equity investors.

The rationale is that investment bankers are more concerned with the value of the company as a whole, regardless of the company's claimants - that is, what portion of firm value belongs to creditors, and what portion belongs to shareholders. Meanwhile, as a private equity investor, your focus is on the cash flows you receive as an equity investor, since the creditors have to get paid before you receive anything.

As for the mechanics behind each method, NGH09 is spot on.

Sep 29, 2010 - 12:29am
...as a private equity investor, your focus is on the cash flows you receive as an equity investor, since the creditors have to get paid before you receive anything.

wrong. as a PE investor you want unlevered free cash flow because you want to know how much cash is available for debt payment.

Sep 29, 2010 - 1:08am

You're absolutely right - when you're considering a transaction, a big part of the LBO analysis is to look at what kind of leverage you can take on, and for that you want unlevered FCF's. Intuitively though, FCFE's tend to be reserved for equity investors, and a high-level PE perspective (as opposed to a pre-transaction modeling perspective) is useful for understanding the big-picture difference between the two methods.

Sep 29, 2010 - 1:12am

Well to complete the question... The reason you add back depreciation is because you deducted it out of EBITDA to get EBIT and then cash taxes that will be paid out, as depreciation lowers your taxes owed. However, the deduction doesn't account for an outflow of cash, and as mentioned above is added back to account for that, reflecting a higher free cash flow figure.

Sep 29, 2010 - 1:15am

FCFF/FCFE in CAPM/WACC Model - Unlevered/levered beta (Originally Posted: 05/22/2014)

I've read all the threads and there seems to be some disagreement on this...

So two parts to this question
1) Just to confirm FCFF = UFCC and FCFE= LFCC
2) To calculate a DCF using FCFF , you use WACC, and for the beta you deleverage the beta and releverage it using the specific capital structure
3) To calculate a DCF using FCFE, you use the CAPM model and then you just use the unleveraged beta? Is that right? You use the unleveraged beta since thats what the equity holders are exposed to?

Thanks guys

Sep 29, 2010 - 1:16am

2) Usually, you take the unlevered beta of the industry, then you releverage this beta using the leverage of the company // Bu * (1+(1-T)*D/E))
3) I don't know for sure but I'd would say that equity holders are exposed to the level of debt (the higher the debt, the greater the risk, which has an impact of the cost of equity). So to my opinion, you have to use a beta levered.

After all, the main difference in discounting FCFF vs. FCFE is that you're using the WACC in FCFF and the cost of equity in FCFE. CAPM method and key metrics shouldn't change.

Hope it helps.

Sep 29, 2010 - 1:21am

True. But the shareholders will expect a higher return if the company has a great amount of debt. It'll have an impact on your valuation. So I don't think you can determine your cost of equity without taking into account the capital structure...

Wait for other comments.

Sep 29, 2010 - 1:30am

you have to project out to the point where fcf becomes positive... can take 10 - 15 year projection periods at times but either way, you can discount the negative cash flows and sum them up to get the pv of the future cash flows. the reason you have to project out until the company becomes profitable is so you can estimate terminal value based on a multiple or perpetuity growth

Sep 29, 2010 - 1:36am

I've seen an 18-year DCF for an alternate energy company before, so it certainly can be done, but as noted before... if you're looking at a company from a more traditional industry, once you get beyond 5-7 years, your already unlikely assumptions just become totally unrealistic. Aside from the difficulty in predicting the company's performance, you have to start seriously considering a lot of outside influences and it just becomes outrageous.

Best bet is to use a multiples-based approach. As noted above, you'll likely have to look at revenue multiples (guessing EBITDA is negative and won't be sufficiently positive for another 3-4 years). A DCF doesn't make much sense in this situation.

Sep 29, 2010 - 1:37am

Agreed with being able to do long term DCFs. I have worked on many of these (often 15+ years) which have been presented to Biotech management / Boards (comprised of mgmt from publicly traded profitable companies / VCs) which have never questioned validity of methodology but rather specific underlying assumptions (discount rate / time to approval etc.) for the analysis while conceding there is an element of art to valuation - and values can get crazy. One of the underlying assumptions should be to POS (probability of success) adjust your cash flows i.e. there is plenty of literature around success rates for CNS/Oncology etc. drugs going from Pre-Clinical to Approval, Phase I to approval etc. and while timing through the FDA is never certain, it can be ballparked within reason. You also need to make sure you are discounting corporate overhead, NOLs, and we usually excluded cash (cash drives current value (development) of the assets). Many of these companies have zero revenue, and may have some milestone payments in the future (i.e. $xmm upon successful Phase II etc.) which should be factored in.

Any valuation needs to be compared to other methods, and I also agree using multiples (we rarely used revenue multiples) but rather a discounted P/E comparing the company being valued to other biotechs with a similar products focus (i.e. CNS/Oncology etc.) who are profitable. If for example Company A is the company being valued and it has a Oncology drug coming online in 2014, and Company Z is a current commercial stage Oncology company with an oncology focus, you would apply Company Z's 2011 multiple to Company A's fully-taxed POS adjusted earnings for 2015/2016 (whenever normalized sales hit) and discount that back to get a PV of the equity.

While recognizing limitations on all of these (DCF assumptions after a few years; problematic to assign discounted multiples - i.e. how do you find a multiple for a wonder drug company that has no peers?) they are recognized in the biotech / VC / Pharma communities and are used in-tandem to reach a valuation point. I have never been in a meeting with management or a board where they have completely dismissed the DCF.

Sep 29, 2010 - 1:38am

UCF, FCF, LCF (Originally Posted: 02/11/2007)

unlevered cashflow, free cashflow, levered cashflow...
can someone explain the difference between these three and which give EV, which give market cap?

Sep 29, 2010 - 1:41am

correct me if I'm wrong, but I believe UCF = FCF

While LCF = UCF - (1-t)rD

where t = taxes; r = interest rate on debt and D = amount of debt.

As seen in the equation, the difference between UCF and LCF is that LCF takes out the after tax interest payment.

UCF is used in WACC and APV as it is the CF available to all financiers (ie it doesnt take out payments to debt financiers). Therefore, it will give you EV

LCF shouldnt be used in WACC or APV, but FTE, and will give you the value of equity holdings.

Of course, if you are dealing with an all equity firm, it doesn't matter if you use LCF and UCF.

Sep 29, 2010 - 1:48am

EV Calculation using Levered FCF (FCFE) vs Unlevered FCF (FCFF) (Originally Posted: 12/07/2015)

Hi, my interviewer asked me this:

EV =equity value + Net Debt
DCF using FCFF = EV
DCF using FCFE = equity value

if I calculate EV by DCF using FCFE (hence Equity Value) and add Net Debt, how/why would it be different from the EV calculated by DCF using FCFF?

Thanks guys.

Sep 29, 2010 - 1:49am

Because in a levered DCF you're also taking into consideration the effect of adding (paying down) new (existing) debt in calculating FCF. Also, in a levered DCF, you start out with Net Income while in an unlevered one you start with NOPAT.

Sep 29, 2010 - 1:51am

I could be mistaken but aren't "Free Cash Flow to Equity" and "Levered Free Cash Flow" different things?

If you want to apply the dcf methodology to FCFE to calculate equity value, you would need to adjust the discount factor. Since you are using FCFE, you discount with only the cost of equity not the WACC.

Sep 29, 2010 - 1:55am

I don't know the answer but I will think about it this way: we are basically comparing the NPV of the saved debt payments vs. the net debt.

So if net debt is $100mm is that suppose to equal to the NPV? Assuming we have $0 cash, 40% tax rate, and a 10% interest rate. $6mm of cash saved each year discounted by 10%*(1-tax rate) equal to $100mm. So if it is a interest-only loan then the NPV will equal to total debt (assuming discount rate equals interest rate).

Therefore, there are two reasons for them to be different.
1.) we are discounting the cashflow with WACC, which is different than the interest rate
2.) principal payment will decrease the NPV further which decrease the equity value further

Just thinking out loud here

Sep 29, 2010 - 1:56am

DCF - FCFE or FCFF? (Originally Posted: 10/02/2015)

We can build a DCF to get a target Mkt Cap either using FCFF and deducting net debt at the end, or directly calculate a target mkt cap using discounted FCFE. For the FCFF we discount with a WACC and for FCFE with the cost of equity. But anyone who can DCF will know this gives different results. Does anyone know why / which is correct?

Sep 29, 2010 - 1:58am

You can use either, it gives a range of where your projected intrinsic value should lie around within your DCF. This is also a common interview question that piggy backs off of this concept. FCFF gives you the cash flows entitled to all both debt and equity holders (which is why your exit multiple could be Enterprise Value/EBITDA). And FCFE is the cash flows entitled to solely equity holders (your exit multiple would have to be based on an equity value metric). The common metric used is FCFF because it is capital structure neutral.

Sep 29, 2010 - 1:59am

Confusion about Levered/Unlevered FCF vs Levered/Unlevered Beta? (Originally Posted: 02/27/2016)

Hello all,

I've read all the posts on could find on this topic, and am confused between FCF and beta.
1) To calculate a DCF using unlevered FCF, you use WACC, and for the beta you unlever the beta because it will give you the enterprise value.
3) To calculate a DCF using levered FCF, you use the CAPM model and then you just use the levered beta to get equity value.

My confusion is that unlevered FCF is of interest to all holders of capital because it excludes the financing effects of debt, but unlevered beta is of primary interest to equity holders to see how much risk they are taking in the firm's equity? Could you all please clarify my thinking?

Sep 29, 2010 - 2:00am

Think about it this way, unlevered beta is the risk of the asset (business risk and operating leverage). Levering it accounts for any risk from debt in the business (remember equity is always junior to debt). More debt relative to equity means more CFs to debtholders before equity holders get their cash.

In regards to 1), You still use levered beta when constructing DCFs using Unlevered FCFs/FCFF in the CAPM in the WACC calculation. Remember you're now looking at all CFS available to the firm, thus your taking into account all CFs available to debt and equity holders. So, you still have to account for the fact that more debt means more CFs to debtholders before equityholders. So, you calculate this risk by using the cost of equity (calculated from CAPM) and debt weighted by their proportions in the capital structure.

You would use the unlevered beta for something like an Adjusted Present Value Model. This is where you look at a company as if it had a capital structure with 100% equity and then you add back the tax benefits of interest payments on debt while factoring in the cost and probability of bankruptcy.

Sep 29, 2010 - 2:02am

DCF Question/Problem - FCF > EBITDA? (Originally Posted: 05/28/2015)


Running a basic DCF on a software company. Running into an issue getting down to FCF. The company lumps in Dep+Amort into SG&A expense, and despite some ambiguity there, I'm still having trouble getting to the numbers in most analyst reports (Picture Attached).

For instance, in the picture you can see EBITDA for 2014 to be 16.2. The Net Change in WC is an increase of 4.3, but the report says that even if you leave WC out of the calculation, FCF is greater than EBITDA ($18.0). So given the standard equation (Unlevered Free Cash Flow = EBITDA - CAPEX - Working Capital - Taxes)...that must meant that Capex or Taxes is positive?....I think there are possibly tax credits but the company still records an income tax expense of $2.6M on their IS.

Thoughts? Any help is appreciated!

EDIT: WSO Scaled my picture weirdly, heres another link: https://i.imgur.com/Ko4eDR0.png

Sep 29, 2010 - 2:07am

Unlevered FCF - tax item? (Originally Posted: 12/13/2014)

So I know that UFCF can be calculated using one of the two:

- tax
- capex
- change in NWC


- tax
+ DA
- capex
- change in NWC

My question is about the "tax" item on both of the above - how is it calculated? Is it tax on just EBIT (because we want unlevered CF), tax on EBITDA or is it the absolute tax value from the P&L?

For instance if EBITDA =100, DA = 20, net interest =10, and tax rate = 20%, then the 3 possibilities I listed above would be:
a) Tax on EBIT: (100-20) * 0.2 = 16
b) Tax on EBITDA: 100 * 0.2 = 20
c) Tax in the P&L: (100-20-10) * 0.2 = 14

So all 3 different. Which one is it?

Plus one more question - how does tax behave when I want to calculate LFCF from UCFC? Do I need to do anything with it?

Sep 29, 2010 - 2:08am

First way doesn't seem right, you've got to subtract d&a to get your real 'unlevered' tax.

Ideally, you want unlevered cash taxes paid: tax expense on the income statement + change in deferred tax assets + change in tax receivable - change in tax payable + Interest tax shields (interest expense * marginal tax rate).

Most of the times you will find a note 'cash taxes paid' in the financial statements, you just have to add interest tax shields to it.

Sep 29, 2010 - 2:12am

I was always under the impression that you find income taxes from EBT and then just subtract that value (also just found on the income statement) from EBITDA to get EBIAT. Then you get UFCF from EBIAT-CAPEX-Change NWC. Is that not right? Assuming you use the same value of income taxes from the income statement, both the formulas OP listed are the same.

Sep 29, 2010 - 2:13am

You are making this way too complicated. You can calculate FCFF from any starting point if you understand how it's derived. To illustrate what I mean assume:

EBITDA = 100
D&A = 20
Tax rate = 20%

Therefore EBIT(1-t) = 64
EBIT + D&A = 84.

EBITDA (1-t) = 80

Then add back taxes saved due to depreciation : D&A (t) = 20 x 0.2 = 4

Therefore 80 + 4 = 84 as above

Sep 29, 2010 - 2:17am

Conflicting sources, true definitions of levered and unlevered fcfs? (Originally Posted: 11/08/2015)

Why does this link say that:
"Levered Free Cash Flow : Cash Flow From Operations - Capital Expenditures + Interest Income & Expense
Unlevered Free Cash Flow : Cash Flow From Operations - Capital Expenditures"


I'm hoping you guys might be able to confirm that it's actually the other way around? unlevered adds back in i expense and subtracts i income, right?

Thanks in advance

Sep 29, 2010 - 2:24am

DCF w/negative FCF first few years (Originally Posted: 06/22/2011)

I know you generally wouldn't use a DCF model to value a start up in the early stages, but what if you're looking at a company transitioning their business into a newer market for them (along the lines of manufacturing), with only a couple years of work under their belts - resulting in 3-5 years of projected negative FCF due to low EBIT margins and high capex/NWC requirements?

If you have evidence of contracts to reasonably support sales forecasts, but the business just needs a few years to get going before generating positive FCF, and you understand the industry, would you still opt out of doing a DCF for another valuation approach (multiples)?

I figure it would place too much emphasis on terminal value, but wonder what the precedent in these types of situations are.

Sep 29, 2010 - 2:33am

triangulate a range thru public comps (forward multiples only), precedents, and DCF. Do not use a WACC inferred from public comps as is unless you feel the risk is comparable (don't use Google's WACC just because this is an internet startup), if the WACC feels low (e.g. a 10%-15% WACC is stupid wrong for a growth/early-stage equity imo) adjust upwards using small cap/illiquidity risk premia (few companies put studies out there on what this premia should be...). Also seen people use hardcoded return expectations for VC/growth type returns instead of WACC to PV FCFs and TVs. I've also seen people adjust public comps downward as a margin of safety. Back to alex's point, your perspective will morph if you are a banker selling this thing or whether you're a buyer trying to find good value for growth.

Sep 29, 2010 - 2:34am

why add i expense and subtract i income when moving from levered to unlevered fcfs? (Originally Posted: 10/29/2015)

I get that levered fcf is CF from operations- capex. but then if you want unlevered fcfs you have to -i income and +i expense. But why? Is it because with levered fcf you've already taken i payments into consideration? And in order to unlever fcf you have to add/ subtract them back in?

Thanks in advance

Sep 29, 2010 - 2:37am

Not sure if these guys made it clear or not. If you just took the CFO number + Net IntEx - CapEx for UL FCF, you would have an incorrect income tax number (based on your tax rate having been applied to levered pre-tax income). You need to strip the Net IntEx number out and reapply your tax rate to an unlevered pre-tax net income number.

Sep 29, 2010 - 2:38am

Debt / levered or unlevered FCF? (Originally Posted: 12/22/2012)

I've seen professionals use both debt / levered and debt / unlevered - which do you use and why?

Personally I'd say Levered FCF would be a strong measure of CF before Financing, unlevered FCF would probably be better for a debt valuation.

Sep 29, 2010 - 2:39am


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Sep 29, 2010 - 2:40am

unlevered for the metrics, basically showing you the "yield" aka coupon you can afford to pay. You would use levered to evaluate % of debt you can pay off every year, which is good to know but doesn't tell you much

Sep 29, 2010 - 2:42am

yes, I should have added that I was looking at it from a credit investor perspective. But if you have control over a company then it does matter

Sep 29, 2010 - 2:45am

simple fcf question (Originally Posted: 02/03/2010)

When doing a DCF valuation, you can either calculate free cash flow to the firm or free cash flow to equity. In what situations or transactions would it make more sense to value FCFF and FCFE?

Sep 29, 2010 - 2:46am

depends whether you are an investment banker or an equity investor

if you are an investment banker, you just want to value the company, so you value the cash flows to the firm
if you are an equity investor, you want to value the cash flows that you will receive after debt payments and other obligations are paid (cash flows to equity)

Sep 29, 2010 - 2:47am

I would also add that advisors usually use FCFF and WACC to calculate enterprise value and then subtract market value of debt to arrive at the value of equity. The exception to this is financial companies - banks, insurers, etc. In case of those entities the method of choice is FCFE and cost of equity. The reason to do is stems from the fact that "we cannot value operations separately from interest income and
expense, since these are important components of their income. Another
distinction involves our concept of invested capital, which focuses on a company's
operating assets and is indifferent, within bounds, to how those assets
are financed. However, financing decisions (the choice of leverage, for
example) are at the core of how banks and insurers generate earnings." (Copeland, Kohler, Valuation 4th ed).

Sep 29, 2010 - 2:48am

DCF and FCF (Originally Posted: 10/23/2012)

When we do a DCF model, we predict a set of future cash flows, discount them to some rate and get a present value.

I was thinking a bit about the validity of such a model.

Instead of thinking in shares I'd rather think in terms of the whole business. Suppose I buy a business for 100m. Suppose it is the case that I cannot ever sell the business. When would I buy it?

Well, since I own the business, I can distribute all the cash from FCF to myself. Hence if the PV of the FCF stream is > 100m, it's worth buying.

Suppose that I would be able to sell the business at end of year 5. Then what is the value?

It would be cash flows (c1,c2,c3,c4,c5) + p_5 (price at end of year 5). But note that by the same logic, p_5 >= PV of cash flows c6,c7... at year 5, so discounting them back to year 0, we have that taking the first 5 cash flows and selling at year 5 gives us at least as good as the PV of (c1,c2.....)

Of course in practice, by the year 5 forecasts for future cash flows may have changed, but in theory it makes sense.

However, suppose I've bought the whole business but someone else makes all the decisions. I don't really have a say. This is just to simulate when I, as a personal investor, buy a small number of shares but can't influence company decisions.

Now if the company continues to distribute all FCF as dividends, there's no change.

If the company puts FCF into cash there will be some slight loss in value. 1 Dollar of cash left in the company increases the value of the company by 1 dollar at that moment (because the total price of the company should go up by exactly 1 dollar, all else remaining equal).

If the company puts FCF into investments, it'll be better or worse than getting it as a dividend depending on how the investments do. Similarly if the company pays down debt.

BUT suppose a company puts FCF into acquisitions and R&D, presumably with the intention of generating greater FCF. In this case, isn't there the danger of double counting?

For example, suppose at the end of year 1, the company generates 10m of FCF. In our DCF analysis, we add 10m/(1+i) to the PV, where i is the discount rate.

But then suppose that the company puts all this FCF into Research. And then, starting from year 5 onwards, the research bears fruit and the company gains an additional 1m in FCF per year.

But then, aren't we double counting the FCF as a result of this? We are not subtracting the 10m of FCF that went into research but adding the 1m per year of FCF that happened as a result of it.

A similar point applies for acquisitions. Although, acquisitions can be sold later on but not necessarily at a price that offsets the original cost.

Sep 29, 2010 - 2:49am

what do you mean double counting? double counting in the DCF analysis?

Fear is the greatest motivator. Motivation is what it takes to find profit.
Sep 29, 2010 - 2:50am

If the company puts FCF into investments, it'll be better or worse than getting it as a dividend depending on how the investments do. Similarly if the company pays down debt.

BUT suppose a company puts FCF into acquisitions and R&D, presumably with the intention of generating greater FCF. In this case, isn't there the danger of double counting?


please explain why you think aquisitions and R&D are different to investments?
"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper
Sep 29, 2010 - 2:51am


Well if you invest in stocks or bonds for example, it may generate revenue but that's not added to operating cash flows is it? So then when you count future cash flows you aren't counting it twice.

As opposed to research and acquisitions, which may change the operating cash flows.

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