How do we include leases in the free cash flow of A DCF? Well, let's start by looking at a classic free cash flow calculation. At the top here, you start with EBIT, take off tax on EBIT to get to nopat, and then you add back D&A because it's not a real cash flow. Subtract CapEx instead because it is a real cash flow and then you plus or minus any other operating cash flows such as OWC operating working capital. Now, including leases in a free cash flow just means you have to add two extra things here, but to help you understand it, let's have a think how a purchase of PP&E, property plant equipment, would impact the free cash flow. Well, if I bought some PP&E, a warehouse maybe, I would have to include the CapEx in here and I'd add back the D&A on it. Just those two things. CapEx on my warehouse and D&A on the warehouse. And if we decide instead of buying it to lease it, we have to do exactly the same thing. We have to include it within CapEx and D&A. With the CapEx the present value of the new leases should be included as CapEx, and this figure is often included in the accounts for many companies that do leases. The other half is you have to add back the D&A on for instance, our warehouse that we're leasing. The D&A add back must include depreciation on the lease assets. If we were looking at an IFRS company, the depreciation on the leased assets would be given to us in a set of accounts fantastic. You just add it back. For US GAAP the depreciation portion of the rent expense had to be calculated by us. And the calculation here is normally two thirds of the rent expense. Two thirds is depreciation, one third is interest. An extra consideration has to be given to EBIT under US GAAP, EBIT must exclude the interest portion of rent expense. How do we calculate that? That's going to be the one third of the rent expense, depreciation was the two thirds. So now we've got all of the adjustments that need to be made. We need to adjust EBIT, we need to adjust D&A and we need to adjust CapEx, and now leases can be included in my DCF.

The big question we get though is, hang on, can't I just include leases in the EV equity bridge? I think I could just calculate my free cashflow as normal and then just put the current lease liability into my EV equity bridge right at the end of my DCF. That's my is done. I don't need to worry about all of this free cash flow. Unfortunately, that's wrong though. The lease liability being included In the EV etti bridge is the current lease liability that a company has at the moment, but many companies have lease liabilities that gradually grow over time. We need to include that growth within the free cash flow forecast period.