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Price/Cash Flow Ratio

Is my CF computation below correct?

Net income per share=$8  Price per share=$200  Depreciation per share=$4  Interest expense per share=$3  Marginal tax rate=35%

CF = [8/(1 - 0.35) + 3 + 4] - (8/0.65 - 8) = $15

Therefore, P/CF = 200/15 = 13.33

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It depends on what CF is referring to: FCFF (free cash flow to firm) or FCFE (free cash flow to equity).

In this situation (note that there is no CAPEX or change in working capital given), if CF = FCFF

FCFF = Net income + non cash charges (ie, depreciation) + after-tax interest expense

FCFF = 8 + 4 + 3(0.65) = 13.95

Note that we added back the after-tax interest expense because FCFF is cash flow available to stockholders and bondholders. Therefore FCFF is pre interest.

If it’s FCFE, you can ignore the addback of the after-tax interest expense.

FCFE = Net income + non cash charges (ie, depreciation)

FCFE = 8 + 4 = 12

Now you can calculate your P/CF ratio based on either of those two, depending on whether the question specificy it’s free cash flow to the firm or free cash flow to equity.

Analyst0718 wrote:
It depends on what CF is referring to: FCFF (free cash flow to firm) or FCFE (free cash flow to equity).

Or CFO.

Or something else.

Simplify the complicated side; don't complify the simplicated side.

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http://financialexamhelp123.com/

Hi. The CF I’m referring to is CFO. In that case, I hope my computation is correct, is it not?

It’s incorrect. If It’s CFO, you do net income + depreciation

CFO = 8 + 4 = 12

In most cases CFO = net income + NCC (eg, depr & amor) + change in net working capital

CFO is after your interest expense, but you want to add back your deprecation because deprecation is a non cash charge. Does that make sense? 

Yes. Thanks for clarifying that. Much appreciated.

Shouldn’t we be adding the interest expense back as well as it is a non-operating expense? What is the rationale behind not adding it as well?

avmachado wrote:
Shouldn’t we be adding the interest expense back as well as it is a non-operating expense? What is the rationale behind not adding it as well?

US GAAP treats interest expense as a non-operating expense, but cash interest paid as an operating cash (out)flow.

There is no rationale; it’s just stupid.

Simplify the complicated side; don't complify the simplicated side.

Financial Exam Help 123: The place to get help for the CFA® exams
http://financialexamhelp123.com/

That’s crystal clear! Thanks!