Unlevered free cash flow, line by line
“How do you calculate unlevered free cash flow?”
It's the engine of the DCF. Interviewers check that you start from the right line, tax the right number, and know why interest is left out.
Unlevered FCF is the cash the business throws off before paying any investor: after-tax operating profit, plus non-cash charges, minus what it must reinvest.
The build
EBIT × (1 − tax rate) gives NOPAT, the profit the operations would earn if the company had no debt. Add D&A, which reduced EBIT but wasn't cash. Subtract capex, the real cash spent on long-term assets. Subtract the increase in net working capital, cash tied up in receivables and inventory as the business grows.
- 1EBIT = 18% × 800 = $144.
- 2NOPAT = 144 × 0.75 = $108.
- 3+ D&A 30 − capex 45 − NWC increase 12.
- 4Unlevered FCF = 108 + 30 − 45 − 12 = $81.
Why “unlevered”?
Interest is a payment to lenders, one of the capital providers the DCF is valuing on behalf of. So it stays out of the cash flow. The cost of debt shows up instead in the discount rate (WACC), including its tax benefit. Count interest in both places and you'd double count it.
Don't tax EBITDA. D&A is tax-deductible, so taxes are computed on EBIT. Starting from EBITDA, you'd subtract D&A, tax, then add D&A back: same answer, more chances to slip.
Dashed: cash flow that year. Filled: what it's worth today. The further out, the more it shrinks.
Try dragging FCF growth and watch EV.
Say it like this
Unlevered free cash flow starts with EBIT, which I tax at the company's tax rate to get NOPAT. Then I add back non-cash charges like depreciation and amortization, subtract capital expenditures, and subtract the increase in net working capital. It's the cash available to all capital providers before any debt payments, which is why it's discounted at WACC.
Traps to avoid
- ✕Starting from net income for an unlevered DCF. Net income is already after interest.
- ✕Adding capex or subtracting D&A, flipping the signs.
- ✕Including interest expense or debt repayments.
What they'll ask next
›Should you add back stock-based compensation?
It's debated. Many practitioners don't, because SBC is a real cost to shareholders through dilution. If you add it back, account for the dilution elsewhere.
›What's the difference from levered FCF?
Levered FCF is after interest and required debt repayments, so it belongs to shareholders and is discounted at the cost of equity to give equity value.
›Why do working capital needs reduce FCF?
Growth ties up cash in receivables and inventory before customers pay; that cash isn't available to investors.
Check yourself
Which is the standard formula for unlevered free cash flow?
Put it all together
Build a full five-year DCF and decide if the stock is cheap.