How does debt financing impact DCF calculations?

Debt financing has a significant impact on Discounted Cash Flow (DCF) calculations, primarily because it alters how cash flows are treated and analyzed. When a company uses debt to finance its operations or projects, it introduces an obligation to make interest payments and repay the principal, which influences the overall cash flows available to equity holders.

The presence of debt affects both the net income and cash flow figures in the DCF model. Interest payments are typically deducted from earnings before calculating taxes, which can lead to lower net income figures in the company's financial statements. However, this does not impact cash flows directly, as interest payments are accounted for in the cash flow from operating activities.

Additionally, incorporating debt into the DCF analysis affects the company's weighted average cost of capital (WACC), which is crucial for discounting future cash flows. Since debt is generally cheaper than equity, the overall cost of capital may decrease when more debt is introduced, with the resulting cash flows being discounted at a lower rate. This can ultimately lead to a higher valuation, illustrating that debt financing not only changes cash flow dynamics but also the way in which future cash flows are assessed and valued.

In summary, debt financing alters cash flow analysis by changing the cash flow dynamics, the WACC used in