Which statement accurately describes unlevered DCF and levered DCF?

Which statement accurately describes unlevered DCF and levered DCF?

• A. Unlevered DCF discounts cash flows at cost of equity; Levered DCF uses WACC.
• B. Unlevered DCF arrives at enterprise value; Levered DCF arrives at equity value.
• C. Unlevered DCF ignores debt; Levered DCF ignores cash.
• D. Unlevered DCF uses dividend discounting; Levered DCF uses residual cash flow.

Answer: (B)

Unlevered DCF reflects the value of the whole firm, independent of how it’s financed. It uses cash flows available to all capital providers (free cash flow to the firm) after operating needs and reinvestment, and it discounts those cash flows with the weighted average cost of capital. Because WACC blends the cost of debt and equity, the result is the enterprise value—the value of the business as a whole, before any debt payoffs. Levered DCF, on the other hand, uses cash flows available to shareholders after debt obligations (free cash flow to equity) and discounts them at the cost of equity. This approach directly yields the equity value, since it accounts for debt payments and financing structure through the cash flows and the equity discount rate. So the statement that unlevered DCF arrives at enterprise value and levered DCF arrives at equity value is the best description. The other options mix up the discount rates and the types of cash flows, and aren’t aligned with how unlevered and levered DCF are normally formulated.

Unlevered DCF reflects the value of the whole firm, independent of how it’s financed. It uses cash flows available to all capital providers (free cash flow to the firm) after operating needs and reinvestment, and it discounts those cash flows with the weighted average cost of capital. Because WACC blends the cost of debt and equity, the result is the enterprise value—the value of the business as a whole, before any debt payoffs.

Levered DCF, on the other hand, uses cash flows available to shareholders after debt obligations (free cash flow to equity) and discounts them at the cost of equity. This approach directly yields the equity value, since it accounts for debt payments and financing structure through the cash flows and the equity discount rate.

So the statement that unlevered DCF arrives at enterprise value and levered DCF arrives at equity value is the best description.

The other options mix up the discount rates and the types of cash flows, and aren’t aligned with how unlevered and levered DCF are normally formulated.