What unlevered free cash flow means
Unlevered free cash flow estimates cash generated by core operations after taxes and reinvestment but before discretionary distributions to lenders or shareholders. Because interest is excluded from the operating cash flow definition, differences in capital structure do not drive the result.
FCFF is the cash flow used to estimate enterprise value. In a DCF, projected FCFF is discounted using the weighted average cost of capital. After calculating enterprise value, analysts normally subtract net debt and other senior claims to reach an implied equity value.
The formula is a model, not a reported GAAP subtotal. Normalized taxes, working capital, non-cash charges and CapEx must all refer to the same period and operating perimeter.
How to calculate unlevered free cash flow
Start with operating profit so financing choices stay outside the cash flow.
- 1
Start with EBIT and remove non-operating or clearly non-recurring items when the model requires normalized operations.
- 2
Multiply EBIT by one minus the operating tax rate to calculate NOPAT.
- 3
Add back depreciation, amortization and other included non-cash operating charges.
- 4
Subtract the increase in non-cash net working capital; add a working-capital release by entering it as a negative increase.
- 5
Subtract capital expenditures required to maintain and grow the operating asset base.
Unlevered free cash flow example
Assume the following annual operating inputs, in USD millions.
| Starting point | Formula or value | When to use it |
|---|---|---|
| EBIT | $1,000 | Operating profit before interest and tax |
| Tax rate | 21% | Normalized operating tax rate |
| D&A | $120 | Non-cash operating charge |
| Increase in NWC | $50 | Cash absorbed by working capital |
| CapEx | $200 | Operating reinvestment |
$1,000 × (1 − 21%) + $120 − $50 − $200 = $660 million of FCFF.
The operations generated $660 million for all capital providers after tax and reinvestment. A firm-value DCF would discount the projected stream of these cash flows at WACC rather than the cost of equity.
FCFF formulas from different starting points
Choose the shortest derivation supported by reliable inputs, then make financing and tax treatment explicit.
| Starting point | Formula or value | When to use it |
|---|---|---|
| EBIT / NOPAT | EBIT × (1 − T) + D&A − ΔNWC − CapEx | Standard operating-profit approach |
| EBITDA | EBITDA × (1 − T) + D&A × T − ΔNWC − CapEx | Preserves the D&A tax shield |
| Net income | NI + D&A + interest × (1 − T) − ΔNWC − CapEx | Adds after-tax interest back to remove financing |
| Cash from operations | CFO + cash interest × (1 − T) − CapEx | Approximation when CFO includes interest and tax treatment is consistent |
Unlevered vs. levered free cash flow
Capital-provider scope determines both the cash flow definition and the valuation denominator.
| Metric | Core formula | Cash belongs to | DCF discount rate |
|---|---|---|---|
| FCFF / UFCF | Before debt financing flows | Debt and equity providers | WACC |
| FCFE / LFCF | After interest and net borrowing | Common equity holders | Cost of equity |
| Simple FCF | CFO − CapEx | Definition must be stated | Depends on adjustments |
Common FCFF mistakes
- Subtracting interest expense in FCFF and then also using WACC, which double-counts financing costs.
- Applying the reported effective tax rate when one-time tax items make it unrepresentative of operating taxes.
- Mixing total working capital with non-cash operating working capital required by the model.
- Discounting FCFF at the cost of equity or comparing it directly with market capitalization instead of enterprise value.
Unlevered free cash flow FAQ
Is unlevered free cash flow the same as FCFF?
They are commonly used as synonyms. Both describe cash available to debt and equity providers before financing distributions, although individual models may differ in normalization adjustments.
Why does FCFF use EBIT instead of net income?
EBIT is before interest expense, so it separates operating performance from the financing structure. Net income can still be used if after-tax interest is added back consistently.
Should FCFF be discounted with WACC?
Yes in the standard enterprise-value DCF framework. FCFF represents all capital providers, and WACC represents their blended required return.
The practical takeaway
FCFF is the clean choice for enterprise-value DCF analysis. Keep interest outside the cash flow, normalize operating taxes and reinvestment, and discount the result with WACC.