Unlevered Free Cash Flow Explained

Unlevered free cash flow is the cash a business generates before any financing effects. It is the cash available to all capital providers, both debt and equity, which is why it is the cash flow you discount at WACC in a DCF. Because it ignores interest, it does not depend on how the company is financed, making it capital structure neutral and comparable across firms.

The formula

Unlevered free cash flow is EBIT * (1 - tax) + D&A - capex - change in NWC. EBIT times one minus tax gives net operating profit after tax, the unlevered earnings before any interest.

You add back D&A because it is a non cash expense that reduced EBIT, then subtract capital expenditures, the real cash spent on long lived assets, and the increase in net working capital, the cash tied up in receivables and inventory net of payables. Interest never appears, which is what makes the figure unlevered.

Worked example

Assume EBIT of 200, a 25 percent tax rate, D&A of 40, capex of 50, and an increase in net working capital of 15.

1. Net operating profit after tax: =200*(1-0.25) returns 150.
2. Add back D&A: =150+40 returns 190.
3. Subtract capex: =190-50 returns 140.
4. Subtract the increase in net working capital: =140-15 returns 125.

Each line ties: 150 + 40 - 50 - 15 = 125.

Where it fits in the model

Unlevered free cash flow is the engine of a DCF. Build it as a clear schedule under the projection so each driver is visible and traceable.

• Start from EBIT on the income statement, not net income, so you stay before interest.
• Apply the marginal tax rate to EBIT, not the effective rate, to avoid baking in financing driven tax effects.
• Pull D&A and capex from the supporting schedules rather than typing them in.
• Compute the change in net working capital as this year's NWC minus last year's, so growth consumes cash and contraction releases it.
• Discount this line at WACC; never discount it at the cost of equity.

Unlevered versus levered FCF

Levered free cash flow starts after interest and is the cash available only to equity holders. It is net income + D&A - capex - change in NWC - mandatory debt repayments + new borrowing, and it is discounted at the cost of equity to value equity directly.

The common error is mixing the two. If you subtract interest but discount at WACC, you double count the cost of debt, since WACC already includes it. Keep unlevered FCF strictly before financing and reserve interest for the levered path.