jgao2003

You ignore which discount rate you should use under different situation.

In fact, you can get the same answer through both ways.

If you don't inclue the interest expense, you are calculating free cashflow to all investors to all investors(including the debtholders), the discount rate that you should use is based on the asset beta under leveraged situation.

If you do include the interest expense, you are calculating free cashflow to equity holders , the discount rate that you should use is based on the asset beta under unleveraged situation.

So it still match because the nominator and the denominator do match.

In fact, I will prefer to use the 2nd option when I calculate the LBO deal. Because the capital structure will change constantly, which means the beta will change, in turn, the discount rate.

Welcome to the magic world of Finance. Hope that solve your question.