Final answer:
WACC represents the average cost of financing a company's assets and is paired with Unlevered FCF in valuation analysis to provide a capital structure-neutral perspective. Unlevered FCF is used to avoid the effect of financing decisions, and when discounted at the WACC, it can provide an assessment of the company's enterprise value irrespective of its financing mix.
Step-by-step explanation:
The Weighted Average Cost of Capital (WACC) reflects a company's entire capital structure, including both debt and equity. WACC is often used to discount Unlevered Free Cash Flows (Unlevered FCF) when performing a valuation analysis to determine a firm's enterprise value. The reason Unlevered FCF is used rather than Levered FCF is because it represents the cash flows available to all capital providers—both debt and equity holders—before the payment of interest expenses. Thus, Unlevered FCF does not reflect any particular capital structure and is considered neutral in this regard. Pairing WACC with Unlevered FCF allows analysts to value a company irrespective of its financing mix, providing a valuation that is capital structure-neutral.
However, there appears to be some confusion in the question's premise: using WACC with Unlevered FCF is appropriate because both are intended to be representative of the company regardless of its specific capital structure. WACC represents the average cost of financing a company’s assets through both debt and equity, thereby reflecting the company’s capital structure. On the other hand, Unlevered FCF represents the cash flows generated by the company's operations that are available to service both debt and equity holders, which are then discounted by the WACC to reflect the time value of money and associated risks.