Question

The notion of free cash flow (FCF). We defined it as EBITDA less changes in working capital less capital expenditures. There are however, other definitions of free cash flow. One is called unlevered free cash flow. It is defined as cash flow from operations PLUS interest expense MINUS capital expenditures. Another is called leveraged free cash flow. It is defined as cash flow from operations MINUS capital expenditures. Which one is more similar to our definition of free cash flow (EBITDA less changes in working capital less capital expenditures). EXPLAIN

Answer 1

Unlevered cash flow is the cash flow which is available to the firm before meeting the interest expenses and it is calculate as

EBIT – Taxes (Calculated without deducting interest expense) + depreciation – Capital expenditure – increase in working capital

Free cash flow is the total cash flow that is available to the firm which is calculated as

EBIT *(1 – taxes) + depreciation – Capital expenditure – increase in working capital

Leveraged cash flows is the cash flow that is available to the firm after meeting its financial obligation which is calculated as

EBITDA – Increase in net working capital – capital expenditure – mandatory debt payments

So, when we say free cash flow what we actually mean is unlevered free cash flow and the cash flow which is available to the firm before making any interest payment.