How does an increase in current assets or an increase in current liabilities affect a DCF?

The key here is their relationship to Working Capital (NWC) (remember this term is synonymous with Net Working Capital (NWC)).

We know that Net Working Capital (NWC) = Current Assets - Current Liabilities.

We also know that the change in NWC is subtracted from EBIAT to get to Unlevered FCF, which we discount in a DCF.

So let’s say that we start off with:

Net Working Capital (NWC) = 4 (Current Assets) - 3 (Current Liabilities) = 1

And let’s say that our Unlevered FCF = 20

Now if we were to increase Current Assets by 2, that would increase NWC by 2. That makes the change in NWC 2 higher, which means we need to subtract 2 from an Unlevered FCF of 20 and our ending Unlevered FCF = 18.

The opposite applies for Current Liabilities. If we increased current liabilities by 2, that would lower NWC by 2. So we would have to subtract -2 from Unlevered FCF and our ending Unlevered FCF = 22.