After tax interest addition to FCFF
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)
tax (40%)= (100-10)* 0.4 = 36 ( to tax official)
NI = 100-10-36= 54 ( to equity holder)
So shouldn’t FCFF = 54 + 10= 64
I understand that there is a benefit of 4 in tax saving due to interest payment, and that benefit is include in NI. But still, in the end the owner is paying 36 ( and not 40, as would have been the case if the interest was not deducted) to the tax official and 10 to the bondholder. And now when I calculate ‘actual’ cash flow to the equity and bondholder, it comes out to be 64 and not 60.
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