What is the first step in the Unlevered FCF model?

What is the first step in the Unlevered FCF model?

• A. Start with EBIT
• B. Start with Revenue
• C. Start with Net Income
• D. Start with Free Cash Flow

Answer: (A)

Unlevered free cash flow is about cash generated by assets before any financing choices, so you want to start from operating profitability that isn’t touched by taxes or interest. EBIT fits that need because it shows earnings from core operations before interest and taxes. From EBIT you apply taxes to get NOPAT, then add back non-cash charges like depreciation and subtract capital expenditures and changes in working capital to arrive at the cash available to all capital providers. Starting with revenue would force you to work through costs to reach EBIT anyway, and starting with net income already includes financing effects, while starting with free cash flow would be circular. So the first step is EBIT.

Unlevered free cash flow is about cash generated by assets before any financing choices, so you want to start from operating profitability that isn’t touched by taxes or interest. EBIT fits that need because it shows earnings from core operations before interest and taxes. From EBIT you apply taxes to get NOPAT, then add back non-cash charges like depreciation and subtract capital expenditures and changes in working capital to arrive at the cash available to all capital providers. Starting with revenue would force you to work through costs to reach EBIT anyway, and starting with net income already includes financing effects, while starting with free cash flow would be circular. So the first step is EBIT.