Finance expenses are excluded from the calculation of free cash flows in a company valuation mainly to avoid double counting of financing costs.

Here are the detailed reasons:

1. The cost of debt is already included in the discount rate:

In the valuation of a project using the Net Present Value (NPV) method, future cash flows are discounted by the Weighted Average Cost of Capital (WACC). This rate represents the average profitability requirement of all the providers of funds (shareholders and creditors).

• The remuneration of financial creditors (financial expenses) is already included in the calculation of the WACC via the cost of debt component.
• Therefore, subtracting financial expenses from cash flows would be tantamount to counting this cost twice: once by reducing the flow, and a second time by discounting this reduced flow.

2. The distinction between operating and financing flows:

The evaluation of a project aims to measure the intrinsic economic performance of the industrial asset (“what the project yields”), regardless of how it is financed (debt or equity).

• Free cash flows represent the cash generated by operations that is available to remunerate all investors (shareholders and creditors).
• Cash flow is therefore calculated as the cash flow that the company would generate if it were financed exclusively by equity, without debt. This is why FCF is also named Free Cash Flow to the Firm.

3. Tax treatment:

The exclusion of financial expenses has a direct impact on the calculation of tax in cash flows:

• In the WACC formula, the cost of debt is taken into account after taxes, i.e. ($\mathrm{D}\times {\mathrm{I}}_{\mathrm{D}}\times (1–\mathrm{T})$). This means that the tax savings resulting from the deductibility of interest (the “tax shield”) are already captured by the discount rate.
• To be consistent, the calculation of free cash flow therefore uses an operating result (EBIT or EBITDA) theoretically taxed before deduction of financial expenses. For this reason, the theoretical after-tax EBITDA ($\mathrm{EBITDA}\times (1–\mathrm{T})$ or the NOPAT (Net Operating Profit After Tax) is calculated, without subtracting interest.

In summary, discounted flows must not include any element of investor remuneration (neither dividends nor financial charges), as this remuneration is fully covered by the discount rate (WACC).