What is the correct approach for using Free Cash Flow multiples?

• A. For both types, use Equity Value
• B. Unlevered FCF requires Enterprise Value
• C. Levered FCF requires Enterprise Value
• D. Unlevered FCF combines both Equity and Enterprise Value

Answer: (B)

Using Unlevered Free Cash Flow (UFCF) typically requires Enterprise Value as the appropriate measure for valuation. This is because Unlevered Free Cash Flow reflects the cash flows generated by a company's operations without the impact of its capital structure, meaning it is not affected by debt or equity financing. Therefore, UFCF is used to assess the value of the entire business, including all sources of capital. In this context, Enterprise Value is the total value of the company, capturing both its equity and debt, and is thus the appropriate valuation metric when working with Unlevered Free Cash Flow.

In contrast, Levered Free Cash Flow (LFCF), which accounts for costs associated with financing including interest payments, specifically relates to the equity holders, making it more appropriate to use Equity Value in valuation contexts involving LFCF. This distinction is essential as it reflects the claims of different stakeholders (debt holders versus equity holders) in the value computation, which helps in ensuring that the multiples used are aligned with the cash flows being evaluated.

Understanding these relationships helps dictate how to correctly apply multiples in different cash flow contexts and why UFCF necessitates an Enterprise Value approach.