Levered Free Cash Flow

Levered Free Cash Flow starts with net income (which already reflects interest expense and taxes) and adjusts for non-cash items and reinvestment. The formula is: LFCF = Net Income + D&A − CapEx − Change in Net Working Capital − Mandatory Debt Repayments + Net New Borrowings. Alternatively, you can derive LFCF from Unlevered Free Cash Flow: LFCF = UFCF − Interest Expense × (1 − Tax Rate) − Mandatory Debt Repayments + Net New Borrowings. The key distinction is that LFCF reflects the actual capital structure of the company, including the burden of debt service, while UFCF is capital-structure-neutral. LFCF can be negative even when UFCF is positive if debt service obligations are large relative to operating cash flow.

The choice between LFCF and UFCF depends on what you are valuing and the stability of the capital structure. Unlevered Free Cash Flow discounted at WACC produces enterprise value — this is the standard approach in investment banking DCFs because it separates operating performance from financing decisions. LFCF discounted at the cost of equity produces equity value directly — this is commonly used for financial institutions (banks, insurance companies) where debt is an operational input rather than a financing choice, making the enterprise value framework less meaningful. LFCF-based DCFs are also used in leveraged buyouts to model cash available for debt paydown and to determine equity returns.

In an equity value DCF, you project LFCF over the forecast period, calculate a terminal equity value (using a terminal P/E multiple or the Gordon Growth Model applied to terminal LFCF), and discount everything at the cost of equity rather than WACC. The result is equity value directly — no need to subtract net debt or add cash. This approach is standard for valuing banks because a bank's interest income and interest expense are core operating items that cannot be cleanly separated from operations. For non-financial companies, the equity value DCF is less common because it requires explicit assumptions about future debt repayment schedules, making the model more complex and less flexible. The free cash flow measure you choose must always match the discount rate: UFCF with WACC, LFCF with cost of equity.