Series 79 practice questionmediumDCF Analysis
In a DCF analysis, unlevered free cash flow (UFCF) is calculated as EBIT(1-t) + D&A - CapEx - Change in Net Working Capital. Why is UFCF used rather than levered free cash flow?
- AUFCF includes the tax benefits of debt, making it more accurate
- BUFCF is always higher than levered free cash flow, providing a more conservative estimate
- CUFCF excludes depreciation, providing a cleaner cash flow measure
- DUFCF represents cash flows available to all capital providers (debt and equity), making it independent of capital structure✓ Correct answer
Explanation
Why D — UFCF represents cash flows available to all capital providers (debt and equity), making it independent of capital structure
Unlevered free cash flow represents the cash flows available to all providers of capital, both debt holders and equity holders, before any financing costs. This makes it capital-structure neutral and appropriate for discounting at the WACC, which blends the cost of debt and equity. Using UFCF allows analysts to value the enterprise independently of how it is financed, which is essential for comparing companies with different leverage levels.
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