How should pension expenses be treated in an unlevered DCF?

In an unlevered Discounted Cash Flow (DCF) analysis, the focus is primarily on the operating performance of a business without considering its capital structure (debt or equity). Pension expenses need to be treated carefully to ensure that the analysis reflects the ongoing operational cash flows appropriately.

When considering how to treat pension expenses, excluding the expected return on plan assets is correct because this return is not a cash outflow of the company. Instead, it is an accounting assumption that affects net income but does not directly impact cash flows. Including it would distort the operating cash flow picture, as the expected return does not represent actual cash being spent from or flowing into the company.

Including all components of pension expense or only operating expenses does not provide a clear reflection of operational performance. Furthermore, subtracting the entire pension expense could misrepresent the company's actual cash flow since certain components like the expected return are non-cash adjustments.

Thus, the approach of excluding the expected return on plan assets ensures that the unlevered DCF captures the true operating cash flows of the business, free from accounting distortions related to pension fund performance.