How do you account for a company rapidly paying off its debt in a DCF?
Answer
This is a trick question! No matter how you get to Unlevered FCF, whether it be through EBIAT or Operating Cash Flow, you don’t take a company’s Interest Expense into account. So, the reduction in Interest Expense through reducing the principal is not picked up anywhere in the DCF.
Why this matters to bankers
Understanding debt’s function in an acquisition helps bankers ascribe accurate valuations.