Earnings before interest and taxes

Unlevered Free Cash Flow Calculation in a Discounted Cash Flow Model

• Report rights infringement
• published: 03 Dec 2013
• views: 34995

Learn why Unlevered Free Cash Flow is important, how to calculate it, and the difference between Levered and Unlevered FCF. By http://breakingintowallstreet.com/ "Financial Modeling Training And Career Resources For Aspiring Investment Bankers" You'll see a real-world example of how to calculate it for Steel Dynamics, a steel manufacturer. Here's an outline of what we'll cover in this lesson... 1. Why is Unlevered Free Cash Flow AKA Free Cash Flow to Firm So Important? Measures cash flow generated by core business... On recurring, predictable basis... And it ignores capital structure - i.e. no net interest expense, debt repayments, etc. So it's arguably the best, most "neutral" view of how much cash a company really generates, resulting in use in the DCF. And it's easier to project than other metrics, such as Levered FCF - need cash/debt/interest/principal projections for that. Other metrics such as EPS or EBITDA/EBIT arguably better for comparison, but Unlevered FCF is best for "measure of core business value." 2. What is Unlevered Free Cash Flow? Try to replicate the Cash Flow Statement, but ignore / exclude certain items... anything non-recurring, non-core-business, or capital structure-related. Think about it this way rather than memorizing a long and complicated formula - understanding the concept always beats rote memorization. Basically you're taking the CFO section, removing net interest expense and tax impact, but keeping most other recurring items... Then, you exclude most of CFI except for CapEx, and exclude all of the CFF section. 3. How Do You Calculate Unlevered FCF? Instead of starting with normal Net Income as you would at the top of any Cash Flow Statement, you exclude net interest expense and recalculate based on Operating Income Times 1 Minus the Effective Tax Rate. Called NOPAT, or Net Operating Profit After Taxes. Then, make non-cash adjustments... D&A; is most common, but can also have Stock-Based Compensation, Deferred Taxes, and so on. Then, Change in Working Capital - best to estimate each item individually to capture real cash flow impact, but can estimate as % of revenue as well. Basic idea is: When this business grows, do we need to put additional cash in to help it grow? Or does the growth itself actually generate cash? Most of the time, you are looking at Current Assets except for Cash and Current Liabilities except for Debt here... but it varies by company and you have to follow what they do. One common exception is Long-Term Deferred Revenue - that shows up under the Change in Working Capital section, even though it's not a Current Liability - because it IS related to the company's operations, and NOT its investing or financing activities. Then, subtract CapEx at the end because that represents re-investment in the company's business... and it's required for almost all companies. Better to estimate using PP&E; schedule, but can approximate using % of revenue approach - generally not too far off. 4. What's Next After Calculating Unlevered FCF? Finish the rest of the model! Calculate Discount Rate, Cost of Equity, WACC, etc., and apply that to calculate NPV of cash flows... Calculate Terminal Value and discount that to its NPV as well. Better scenarios / assumptions for many of the #s here, such as revenue growth, margins, CapEx, etc. Calculate implied share price and sensitivities at the end. http://breakingintowallstreet.com/biws/video-7-dcf-tutorial/