When calculating Unlevered Free Cash Flow (UFCF), how are taxes treated?

The treatment of taxes in the calculation of Unlevered Free Cash Flow (UFCF) is crucial because it directly impacts the financial evaluation of a company's cash generation capability. UFCF represents the cash flow available to all capital providers—both debt and equity—before paying any interest expenses, and thus, it reflects the company's operational profitability and cash-generating capacity without the effects of capital structure.

When considering taxes in this context, the assumption is made that all tax expenses are treated as paid immediately in cash. This approach ensures that the effect of taxes is accounted for in the free cash flow that is available before financing costs are considered. By treating taxes as an actual cash outflow, the model reflects a more realistic picture of the cash generated from operations that will ultimately be available for distribution to capital providers.

This immediate cash flow treatment is integral because it aligns the UFCF calculation with operational performance, making it a more accurate tool for valuing the firm’s underlying cash-generating potential. This method contributes to generating a conservative estimate of potential cash flows, which is particularly beneficial for financial analysis and valuation purposes.