What Is Levered Free Cash Flow?
Levered free cash flow (LFCF), also called free cash flow to equity, is the cash remaining for shareholders after the business has paid its operating costs, taxes, capital expenditures, working capital needs, and its lenders. Because debt holders have already been served, LFCF belongs solely to equity investors.
A common buildup is LFCF = Net Income + Depreciation and Amortization - Capital Expenditures - Increase in Net Working Capital - Mandatory Debt Repayments. Starting from net income means interest expense is already deducted, which is exactly what makes the measure levered.
How It Works
Because LFCF is an equity cash flow, valuation consistency requires discounting it at the cost of equity, not WACC, and the result is equity value directly rather than enterprise value. This levered DCF variant is used less often than the unlevered version because changing debt balances make the projections messier.
Where LFCF truly shines is leveraged buyout modeling: the cash flow available after mandatory debt service determines how quickly a sponsor can pay down acquisition debt, which is a primary driver of equity returns. Lenders also study it to judge whether a borrower can support its debt load with room to spare.
Example
A company earns net income of $90 million, adds back $40 million of D&A, spends $50 million on capex, invests $10 million in working capital, and must repay $20 million of debt. LFCF = $90M + $40M - $50M - $10M - $20M = $50 million available to equity holders.
Note that the same company's unlevered free cash flow would be higher, because it would exclude both the after-tax interest cost embedded in net income and the $20 million repayment. Explaining the difference between levered and unlevered free cash flow, and which discount rate pairs with each, is a staple IB interview question.
Why It Matters
LFCF measures the cash a company can actually distribute to shareholders through dividends and buybacks without borrowing more, making it a core input for income investors and dividend sustainability analysis. In private equity, cumulative levered cash flow over the hold period drives debt paydown and therefore the fund's IRR.
The discipline to remember is the pairing rule: levered cash flows with the cost of equity give equity value, unlevered cash flows with WACC give enterprise value, and mixing the two produces nonsense valuations.
