To value levered FCF, which measure is appropriate?

• A. Equity value.
• B. Enterprise value.
• C. Net income.
• D. Operating income.

Answer: (A)

Levered free cash flow is the cash that remains after a company has paid its debt obligations, meaning it is the cash flow available to equity holders. Because this measure reflects financing activities (interest and debt repayments) and the residual cash flow after those obligations are met, valuing it with equity value is the correct approach. Discounting levered FCF at the cost of equity gives you the value of the equity stock—the amount that would be returned to shareholders.

In contrast, enterprise value is tied to cash flows available to all capital providers before debt service, which is why unlevered free cash flow (to the firm) is used with the weighted average cost of capital to derive enterprise value. Net income and operating income are accounting metrics that don’t directly represent the actual cash that remains after financing, so they aren’t the appropriate targets for valuing levered FCF.