NI includes preferred dividend?

CFA Level II Equities
#1

Hi

In a Fcff calculation question, if the NI is given, do we assume it is NI after preferred dividend or before?

Do we add back Preferred dividend to NI to get FCFF?

Thanks

#2

Thanks for pointing that out. It is added to FCFF. The full equations become

FCFF = NI + NCC + Int(1-tax rate) + preferred dividends - FCInv - WCInv

FCFE = FCFF - Int(1-tax rate) - preferred dividends + Net borrowing + Net issuance of preferred stock

http://www.analystforum.com/forums/cfa-forums/cfa-level-ii-forum/91132255

It is treated as normal debt except there is no tax shield.

#3

Are you sure about adding preferred dividends to FCFF? I don’t see the source of that there.

P&L captures income in form of cash and accruals are separated , FCInv and WCInv are cash outflows. So the only way is that the NI in the formula is NI after distribution of preferred dividends, right? If not, then there is no reason to add back preferred dividends.

#4

This makes no sense, your link to a 6-year-old thread notwithstanding.

Preferred dividends haven’t been subtracted to arrive at net income; there’s no reason to add them back.

#5

Came for this.

S2000, is the FCFE formula with preferred dividends correct? I think so, since FCFE is cash for equityholders, substracting preferred dividends and adding issuance of Preferred Stock has the same rationale of net borrowings. Hope your confirmation.

#6

Yes.

Note, however, that I would be quite surprised to see preferred dividends in a question about free cash flow. That’s not the emphasis of the reading.

#7

I thought exactly the same, preferred dividends are not the focus in this chapter.

Thanks.

#8

OK. Good to see continous vigilance by both. Hope the OP reads this :slight_smile:

#9

Normally, preferred dividends are subtracted from net income, so you should add them back to get FCFF. But I don’t suppose it will be part of the exam.

#10

S200 Magician,

how about this…

FCFF = CFO + Int(1-tax rate) + preferred dividends - FCIn

FCFE= CFO-Pref div ( under IFRS, classified as operating)-FCInv+NB+Net issuance of preferred

#11

There I am again: discounted by 90%.

I believe that preferred dividends are CFF, not CFO.

#12

Reading 35.3.8.3 in 2016 curriculum addresses complex capital structure implications on FCFF and FCFE whereby preferred dividends, if paid during the year, are added back to FCFF and FCFE. Just to be clear the above formula are a real thing, albeit not likely to be tested.

#13

Thanks Kroko for pointing that out. Preferred dividends are added back to “Net Income available to common shareholders” to arrive at FCFF.

#14

Yes, so much important not to confuse “Net Income” with “Net Income available to common shareholders”. That’s the tricky part of this.

Net Income available to common shareholders = Net Income - Preferred Dividends

and when building FCFF formula do not start with NI but with NI available to common.

#15

+1. Know this!