Unlevered vs Levered Free Cash Flow: The Difference, the Formulas, and How to Nail It in Interviews

If you're prepping for investment banking interviews, you will get asked about unlevered vs levered free cash flow. It shows up in DCF questions, LBO questions, and the "walk me through" questions that trip people up.

Here's the short version: unlevered free cash flow (UFCF) is the cash available to everyone who funds the business (debt and equity holders). Levered free cash flow (LFCF) is the cash left for equity holders only, after lenders get paid.

That one difference drives everything else: the formulas, the discount rate, and what value you end up with. Let's break it down so you can explain it cleanly and do the math under pressure.

The Core Idea: Who Gets the Cash?

Think of a company as a pie that two groups have a claim on: lenders and shareholders.

• Unlevered FCF looks at the whole pie. It ignores how the company is financed and asks how much cash the operations generate.
• Levered FCF looks only at the shareholders' slice. It subtracts what lenders get (interest and required principal payments).

"Levered" just means "with debt considered." "Unlevered" means "as if the company had no debt."

Unlevered Free Cash Flow (UFCF)

The Formula

The most common version:

UFCF = EBIT × (1 − tax rate) + D&A − CapEx − Increase in Net Working Capital

That first piece, EBIT × (1 − tax rate), is called NOPAT (net operating profit after tax).

Why Start From EBIT?

EBIT is before interest expense. Starting there keeps financing out of the picture.

Notice that you calculate taxes on EBIT, not on pre-tax income. That's on purpose: you're computing the taxes the company would pay if it had no debt. The tax benefit of interest doesn't disappear, though. It gets picked up in the WACC through the after-tax cost of debt. More on that below.

What It's Used For

• DCF analysis: UFCF discounted at WACC gives you enterprise value.
• Comparing companies: since it's capital-structure neutral, two businesses with different debt loads can be compared on operating performance.

Levered Free Cash Flow (LFCF)

The Formula

LFCF = Net Income + D&A − CapEx − Increase in Net Working Capital − Mandatory Debt Repayments

A quick heads-up: definitions vary a bit by bank and textbook. Some people subtract net borrowing (repayments minus new debt issued) instead of just mandatory repayments. In an interview, state your definition clearly and you'll be fine.

Why Start From Net Income?

Net income is after interest expense, so it already reflects the cost of debt. Then you also subtract principal repayments, because that cash goes to lenders, not shareholders.

What It's Used For

• Levered DCF: LFCF discounted at the cost of equity gives you equity value directly. This is less common in banking but you should know it exists.
• LBOs: LFCF tells you how much cash is available to pay down debt beyond the required amounts, which drives returns.
• Dividend and buyback capacity: it's the cash management can actually return to shareholders.

Side-by-Side Comparison

Worked Example: Same Company, Two Numbers

Let's run both calculations on one company. Here are the assumptions:

• EBITDA: $200
• D&A: $50
• EBIT: $150
• Interest expense: $30
• Tax rate: 25%
• CapEx: $60
• Increase in NWC: $10
• Mandatory debt repayment: $20

Step 1: Unlevered FCF

• NOPAT = $150 × (1 − 0.25) = $112.5
• Add D&A: $112.5 + $50 = $162.5
• Subtract CapEx: $162.5 − $60 = $102.5
• Subtract increase in NWC: $102.5 − $10 = $92.5

UFCF = $92.5

Step 2: Levered FCF

First, get to net income:

• Pre-tax income = $150 − $30 = $120
• Taxes = $120 × 25% = $30
• Net income = $90

Now build LFCF:

• Net income + D&A: $90 + $50 = $140
• Subtract CapEx: $140 − $60 = $80
• Subtract increase in NWC: $80 − $10 = $70
• Subtract mandatory debt repayment: $70 − $20 = $50

LFCF = $50

Step 3: Bridge the Two (This Is Where You Impress People)

You can get from UFCF to LFCF in two moves:

1. Subtract after-tax interest: $30 × (1 − 0.25) = $22.5. So $92.5 − $22.5 = $70.
2. Subtract debt repayment: $70 − $20 = $50.

Why after-tax interest and not the full $30? Because interest is tax-deductible. Paying $30 of interest only reduces cash by $22.5, since it saves $7.5 in taxes. That $7.5 is the interest tax shield.

If you can explain this bridge in an interview, you've shown you actually understand the concept, not just the formulas.

Common Interview Questions (and How to Answer Them)

"Why do we usually use unlevered FCF in a DCF?"

Because it's independent of capital structure. A buyer could refinance the company's debt, so valuing the operations on their own gives a cleaner picture. It also makes it easier to compare companies and to apply a consistent discount rate (WACC).

"Which is higher, unlevered or levered FCF?"

Usually unlevered, because levered FCF subtracts interest and debt repayments. But it's not guaranteed. If a company raises a lot of new debt in a given year and you use the net borrowing definition, LFCF can exceed UFCF. Mentioning that nuance is a nice touch.

"If interest expense goes up by $10, what happens to each?"

• UFCF: no change. It ignores interest entirely.
• LFCF: falls by $10 × (1 − tax rate). At a 25% tax rate, that's $7.5.

"What discount rate do you use for each, and why?"

• UFCF → WACC, because the cash belongs to both debt and equity holders, so you blend their required returns.
• LFCF → cost of equity, because the cash belongs only to shareholders.

Mismatch them and your valuation is wrong. This is one of the most common mistakes candidates make.

"Where does the interest tax shield show up in an unlevered DCF?"

In the WACC, through the after-tax cost of debt: cost of debt × (1 − tax rate). That's why you don't include it in UFCF. Counting it in both places would double count the benefit.

Mistakes to Avoid

• Starting UFCF from net income without adding back after-tax interest. Net income already has interest baked in.
• Taxing EBIT at the actual taxes paid. For UFCF, apply the tax rate to EBIT directly.
• Discounting LFCF at WACC (or UFCF at cost of equity). Match the cash flow to the capital providers.
• Forgetting debt repayments in LFCF. Interest isn't the only cash going to lenders.
• Mixing up the output. UFCF gets you enterprise value. To reach equity value, subtract net debt (and other non-equity claims like preferred stock and noncontrolling interests).

The Takeaway

If you remember one thing, make it this: unlevered FCF is cash for all capital providers, levered FCF is cash for equity holders only. Everything else follows logically:

• UFCF starts from taxed EBIT, ignores financing, uses WACC, and gives enterprise value.
• LFCF starts from net income, subtracts debt payments, uses cost of equity, and gives equity value.
• The bridge between them is after-tax interest plus debt repayments.

Practice the worked example above until you can do it from memory, then try changing one input (like interest or debt repayment) and predicting how each number moves. Once you can do that without thinking, you're ready for whatever version of this question comes your way.