In a standard DCF, which type of cash flow is used to determine enterprise value?

• A. Levered free cash flow
• B. Dividends
• C. Unlevered free cash flow
• D. Net income after tax

Answer: (C)

Unlevered free cash flow is the cash the business generates that is available to all providers of capital—both debt and equity—after taxes and after reinvestment needs, but before any debt financing is considered. In a standard DCF, enterprise value represents the value of the entire firm, not just the equity, so you discount this cash flow with the firm’s cost of capital (WACC). This ties the value to the business’s overall risk and operating performance, independent of how it is financed.

Levered free cash flow would reflect cash flow after debt payments, which corresponds to equity value rather than enterprise value. Dividends are just distributions to shareholders and do not measure the firm’s ability to generate cash for all capital providers. Net income after tax is an accounting profit, not a cash flow measure, and it doesn’t account for capital expenditures or working capital changes that drive actual cash generation.

So the cash flow used to determine enterprise value in a standard DCF is unlevered free cash flow.