6. Unlevered Free Cashflow


Many different types of cashflow exist in a company, from operating cashflows to free cashflow to equity. In this lesson, I'll show you why unlevered free cashflow is a very important cashflow for valuation.

To explore more Kubicle data literacy subjects, please refer to our full library.


  1. Lesson Goal (00:04)

    The goal of this lesson is to calculate the Unlevered Free Cashflow for MarkerCo.

  2. Understanding Unlevered Free Cashflow (00:15)

    Our objective in our Excel model is to value the company MarkerCo by discounting the cashflows in their financial statement projections. The easiest way to do this is to calculate the enterprise value of the company, and then calculate the equity value. As a result, the cashflows we want to discount are cashflows to both debt and equity holders. These cashflows are the cashflows from operating activities to debt and equity holders and the cashflows spent on capital expenditure, typically the purchase of PP&E.

    These cashflows are called the Unlevered Free Cashflow. The term leverage refers to debt. Levered cashflows are cashflows to debt holders, and unlevered cashflows are cashflows to debt holders and equity holders, which is what we want. To calculate unlevered free cashflows, we need to exclude the interest expense from our cashflows, as this cashflow goes to debt holders only.

  3. Calculating Unlevered Free Cashflow (01:56)

    The first step in calculating Unlevered Free Cashflow is to calculate NOPAT, or Net Operating Profit After Tax. This represents the net profit after stripping out the effect of interest payments. We start by taking EBIT, which represents the earnings before tax available to debt and equity holders. We then subtract tax, which is EBIT multiplied by the tax rate. This tax calculation will often be higher than the tax expense in the Income Statement, as there are no interest payments to provide a tax shield. The result of this subtraction is NOPAT. Note that if a company has no financing costs, then NOPAT will equal Net Profit.

    After calculating NOPAT, the next step is to calculate the cashflow adjustments for non-cash charges and changes in operating assets and liabilities. These are the exact same adjustments you would calculate in the operating cashflows section when preparing a Statement of Cashflows. In our case, we have a complete Statement of Cashflows, so we can create these adjustments by linking to the relevant entries in the statement.

    The final step in calculating unlevered free cashflow is to subtract net capital expenditures. The main source of capital expenditure is the purchase and sale of PP&E. In our case, these figures can be found in the Statement of Cashflows, in the section of cashflows from investing activities.

    To calculate unlevered free cashflow, we simply add NOPAT, total adjustments and changes, and net capital expenditure.


Now that we've discussed discount rates, enterprise value, and the different valuation methods, let's move to Excel and start working on the financial model for MarkerCo. In the previous course, we created five year financial statement projections for the income statement, balance sheet, and cashflow statement. As you can imagine, when using the discounted cash flows valuation method we need to examine the cashflow statement of the business. This brings up an important question. Which cashflow do we actually discount? Is it the cashflow from operating activities, investing activities, financing activities, or a combination of the three? Well ultimately it depends on how we want to value the company. Our final valuation will be equity value which will be the value of the shares. However to first get there I find it easier to go to enterprise value first then subtract the debt, add back the cash, and then get to equity value. So the cashflows we're going to discount in our financial model will be the cashflows to both the equity holders and the debt holders. This essentially means the cashflow from operations to both equity and debt holders and the capital expenditures. Which is typically the acquisition of PP&E. This particular cashflow is called the unlevered free cashflow. Leverage relates to debt. Levered free cashflows are free cashflows that take into account debt. Unlevered free cashflows include the cashflows to equity holders and debt holders. We need to strip out the impact of interest expense from our cashflow calculations. To do this I have set up a separate section underneath my statement of cashflows entitled unlevered free cashflow. To calculate the unlevered free cashflows we start with EBIT, which is the operating income before interest and tax payments. EBIT are pretax earnings available to equity and debt holders because interest hasn't been subtracted yet. I simply connect this cell to the cell in the income statement, which is here. I'll copy across for the remaining cells holding the title.

Now I need to subtract taxes which is going to be the operating income multiplied by minus the tax rate which is also in the income statement. Here we go.

And I'll copy across.

This allows me to calculate net operating profit after tax. Essentially this NOPAT figure is the net profit after stripping out the effects of interest. I simply add these two values together.

Given that MarkerCo has no long term debt, I would expect NOPAT to be the same as net profit. Let's skip up to the cashflow statement quickly and check this. In 2020, net profit should be 25.0.

When I skip up I can see that this is the case. You might be tempted to simply use net profit in the unlevered free cashflow calculations because there's no debt on MarkerCo. However, we may run a scenario where we do add some debt on to MarkerCo and then our unlevered free cashflows would need to be updated accordingly. It's much easier to build the formulas correctly at the beginning and allow for scenarios such as including debt on MarkerCo's balance sheet. Once you've calculated NOPAT, we then need to make the same adjustments that we made in the operating cashflows from the statement of cashflows. These include depreciation and amortization changes and changes in operating assets and liabilities. To save some time, I'm going to do this off camera underneath NOPAT.

I now have the same adjustments for non cash charges and changes in operating assets and liabilities in my unlevered free cashflow section as I do in my statement of cashflow section. For my formulas I simply link directly to the statement of cashflows.

Underneath these adjustments, I also subtract net capital expenditures to find my unlevered free cashflows. To do this I simply add my net capital expenditures, my total adjustments and changes, and NOPAT.

Then copy across for the remaining cells. This gives me my annual unlevered free cashflows for MarkerCo.

In the next lesson, we'll calculate the discount rate for MarkerCo and apply this discount rate to the unlevered free cashflows.