Unlevered Free Cash Flow (UFCF)

A DCF calculates enterprise value, which belongs to all capital providers. Therefore, the cash flows must also be available to all capital providers — that's UFCF. If you used levered FCF (which deducts interest payments), you'd be double-counting the cost of debt because WACC already reflects it. Using UFCF discounted at WACC gives enterprise value. Using levered FCF discounted at the cost of equity gives equity value. Both approaches should yield the same result if done correctly.

UFCF = EBIT × (1 - Tax Rate) + D&A - CapEx - Change in Net Working Capital. Starting with EBIT (not net income) ensures interest is excluded. The tax on EBIT uses the marginal tax rate, not the effective rate, to represent the tax the company would pay in an all-equity capital structure. D&A is added back because it's non-cash. CapEx is subtracted because it's a real cash outflow. Changes in NWC capture the cash tied up in (or released from) operations.

Levered FCF = Net Income + D&A - CapEx - Change in NWC + Net Borrowings. It starts after interest, reflecting only the cash available to equity holders. UFCF is higher than levered FCF for companies with debt because it doesn't deduct interest. In LBO models, you may see both: UFCF to measure the business's cash generation, and levered FCF to determine how much cash is available after mandatory debt service to pay down additional debt or fund returns.

Stock-based compensation: some analysts subtract SBC from UFCF because it represents real dilution to shareholders, while others leave it out (treating it as a non-cash charge). The industry is moving toward subtracting SBC, especially for tech companies. Operating lease payments: under the new ASC 842 standard, the principal portion of lease payments may need to be treated similarly to CapEx. One-time items: exclude restructuring charges and other non-recurring costs to get normalized UFCF.