Study Session 11: Equity Investments: Free Cash Flow and Other Valuation Models
While calculating FCFF we add back after tax interest to it ( + int(1-t) ). By definition FCFF is the cash available to providers of the capital i.e equity holders and bond holders. So, shouldn’t we add back the whole interest to FCFF? Why don’t we include the benefit of tax saving due to interest in FCFF calculation?
(Eg: Let’s say there’s an owner, an equity holder, a bond holder, and a tax official standing side by side. The owner now distributes money to each of these in the following manner.
EBIT =100 ,
interest = 10 ( to bondholder)
I have a question regarding the calculation/timing of the terminal value. I searched through old AnalystForum threads, but could not find a concise answer.
Can anyone help derive the formula for DLOC
DLOC = 1 - (1/(1+control premium))
Does anyone have an intuitive explanation of why clean surplus has to hold for residual income valuation? What happens conceptually if the clean surplus does not hold in terms of valuation? Thanks!
Could someone help me understand how to calculate change in working capital investment. I understand, the formula is CA - CL in recent year and subtract last year’s CA - CL. I am getting confused with the addition and subtraction when Accounts Receivables increase or decrease and when Accounts Payable increase or decrease.
Hi, Can someone confirm we are supposed to SUBTRACT bond amorization premium from NI to arrive at FCFF as well as FCFE? I see in my test prep provider they have it marked as adding bond amortization to arrive at FCFE and I’m pretty sure that’s inaccurate, just want to confirm.
‘The residual income model makes no assumptions about future earnings and dividend growth.’
Isn’t ROE an assumption about future earnings?
In the study text, the following statement is given about why Cash and Short Term Debt is excluded from the computation of “Working Capital Investment” for the purposes of computation of FCFF (free cash flow to the firm):
Cash is excluded because it is the change in cash that we are trying to explain.
Notes payable and current portion of LTD is excluded because they carry explicit interest costs and are therefore financing rather than operating items.
I unfortunately did not understand head or tail of this.
Schweser : “The formal definition of FCFF is the cash available to all of the firm’s investors, including stockholders and bondholders, after the firm buys and sells products, provides services, pays its cash operating expenses, and makes short- and long term investments.”
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