Free Cash Flow (FCF)
Cash generated by a business after operating expenses and capital expenditures, available to be distributed to (or reinvested by) capital providers. The core input to a DCF valuation.
Why Free Cash Flow (FCF) matters in interviews
Free cash flow is what actually pays down debt and funds distributions, so it is the number that matters in both a DCF and an LBO. Interviewers ask about it to see whether you can distinguish accounting profit from cash, and whether you know which version of FCF pairs with which discount rate.
How it works in practice
Unlevered free cash flow (free cash flow to the firm): EBIT − taxes on EBIT + D&A − capital expenditure − increase in net working capital. It is the cash available to all capital providers, and it is discounted at WACC.
Levered free cash flow (free cash flow to equity): starts from net income, adds back D&A, subtracts capex and the increase in working capital, then adjusts for mandatory debt repayment. It is the cash available to shareholders, and it is discounted at the cost of equity.
A worked case: EBIT of $400m, a 25% tax rate, D&A of $120m, capex of $150m and a $30m increase in working capital. Unlevered FCF = $400m − $100m + $120m − $150m − $30m = $240m.
What candidates get wrong
- Subtracting interest in an unlevered calculation. Unlevered means before financing; the cost of debt lives in WACC instead.
- Getting the working capital sign wrong. An increase in net working capital consumes cash and is subtracted.
- Taxing EBT rather than EBIT in the unlevered build. Unlevered FCF taxes EBIT so the calculation stays independent of the capital structure.
Free Cash Flow (FCF): frequently asked questions
What is the difference between unlevered and levered free cash flow?
Unlevered free cash flow is calculated before interest and is available to all capital providers, so it is discounted at WACC and produces enterprise value. Levered free cash flow is after interest and mandatory debt repayment, is available only to equity holders, and is discounted at the cost of equity to produce equity value directly.
Why is depreciation added back to free cash flow?
Because it is a non-cash accounting charge. Depreciation reduces reported earnings but no money leaves the business in that period — the cash went out when the asset was bought, which is captured separately as capital expenditure.
Go deeper
This term comes up constantly in valuation interviews and on the desk.
DCF interview questions guideRelated Valuation terms
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