What distinguishes levered FCF from unlevered FCF?

• A. Levered FCF accounts for debt payments; unlevered FCF excludes debt effects
• B. Levered FCF ignores taxes
• C. Unlevered FCF includes interest expense
• D. They are identical

Answer: (A)

The key idea is whether debt service is included when measuring cash flow. Unlevered free cash flow, or free cash flow to the firm, looks at the cash the company generates from its operations before any financing decisions are made. It’s the cash available to all providers of capital (both debt and equity) and excludes debt payments and interest. Levered free cash flow, or free cash flow to equity, starts from that cash flow and then subtracts the payments owed to debt holders—interest and principal—so it shows what remains for equity holders after debt obligations are met. This makes levered FCF directly reflect the financing structure of the company.

So levered FCF accounts for debt payments, while unlevered FCF excludes debt effects. The difference isn’t about taxes alone, and the two are not identical because the levered version incorporates debt service and the tax shield that comes with debt, whereas the unlevered version does not.