What is the first step in a leveraged DCF analysis?

In a leveraged discounted cash flow (DCF) analysis, the first step involves forecasting expected future cash flows after debt service. This is essential because it sets the foundation for understanding the project’s cash generation capabilities once the obligations to debt holders have been satisfied. By focusing on cash flows available to equity holders (after accounting for interest payments and other debt-related expenses), one can determine the level of returns that the equity investors can expect. This practice is crucial in assessing whether the investment is worthwhile from an equity perspective, as it highlights the net benefits remaining after all financial commitments are made.

Determining the equity discount rate typically follows this initial cash flow analysis. It is derived from the risk profile associated with the equity investment and reflects the expected return required by investors. Valuing the leveraged investment comes after cash flows are projected and discounted. It involves applying the discount rate to the projected cash flows to arrive at a present value. The calculation of the initial equity investment is also a subsequent step, as it requires knowledge of the cash flows and valuation to determine how much equity capital is needed to finance the initial acquisition.

Thus, the correct answer is rooted in the principle that cash flow projections are the cornerstone of a DCF model, particularly in contexts where leverage is involved