Why is unlevered DCF typically favored over levered DCF?

Unlevered DCF is typically favored over levered DCF because it focuses on the cash flows generated by the entire business, independent of its capital structure. This approach provides a clear view of the company’s operational performance, as it eliminates the effects of financing decisions such as interest payments and debt. By valuing the business based solely on its operating cash flows, unlevered DCF creates a more reliable and consistent framework for comparing companies with different capital structures.

The process of conducting an unlevered DCF is often seen as more straightforward since it involves calculating the free cash flows available to all investors (equity and debt holders) before financing expenses. This results in less variability in outputs, particularly when comparing firms in the same industry but with differing levels of debt.

In contrast, levered DCF incorporates debt and its costs, which can add complexity and lead to less consistent results, particularly if the company's capital structure changes over time. Evaluating a company's performance on a levered basis can also obscure the true operational capacity of the business since it merges both operational and financing performance into one metric. Thus, unlevered DCF is generally viewed as a more reliable and less time-consuming approach for assessing company value.