In a company with a high debt load that pays down principal each year, how are principal repayments treated in a standard DCF?

In a company with a high debt load that pays down principal each year, how are principal repayments treated in a standard DCF?

• A. You include principal repayments in Cash Flow from Financing.
• B. You ignore them entirely.
• C. You count principal repayments in Free Cash Flow.
• D. You count principal repayments as changes in Revenue.

Answer: (A)

In an equity DCF, you’re valuing cash that goes to shareholders, so financing activities matter. Principal repayments are payments to creditors, not operating results or investments. They reduce the cash available to equity holders, so they are treated as financing cash flows. In other words, you subtract debt repayments in the Cash Flow from Financing (and you’d also add any net new debt issued) when calculating the Free Cash Flow to Equity. If you were using a purely unlevered DCF (FCFF), you wouldn’t include repayments at all in the cash flow line, since financing is kept separate from operating performance.

In an equity DCF, you’re valuing cash that goes to shareholders, so financing activities matter. Principal repayments are payments to creditors, not operating results or investments. They reduce the cash available to equity holders, so they are treated as financing cash flows. In other words, you subtract debt repayments in the Cash Flow from Financing (and you’d also add any net new debt issued) when calculating the Free Cash Flow to Equity. If you were using a purely unlevered DCF (FCFF), you wouldn’t include repayments at all in the cash flow line, since financing is kept separate from operating performance.