Just seen Kaplan material 2014 practice exam vol 1 - morning exam Q7. The question clearly shows interest from the long term loans used to fund the company and other interest --which i presume to be trade creditors, overdraft etc… However when adding back interest on calculating FCFF the suggested answer includes ALL interest. ?I thought one should only include interest re funding eg interest from long term debt esp if the P&L clearly shows different lines of interest. Could someone help???
All interest reduce free cash flow to the FIRM ! duh
I hope you are joking…
FCFF represents cash flow available to all suppliers of capital. AT interest is therefore added back to CFO or NI when calculating FCFF. Interest expense does not reduce FCFF, it is a use of it.
Creditors are not limited to bond holders, and creditors have a claim on the firm’s assets.
You add back any interest expense you deducted on the income statement.
I know creditors, other payables etc have claim on assets but when looking at firm structure Debt + equity etc…its only the long term debt (funding debt) that you are concerned and we dont include creditors, payables,tax payable etc. … Intuition says adding back interest from such creditors doesnt make sense:).
FFCF is cash flow metric to all stake holders of the firm, why would you reduce cash flow to ‘them’ for interest payments the firm is essentially making it itself?
To clarify - you are required to calculare FCFF from net income. To get back to FCFF one needs to add back after tax interest. My original question was - should one add ALL interest (if you are given a split of interest - long term loan interest, other interest expense eg from bank overdrafts, creditors etc). In Scheweser mock exam, ALL interest is added back. My feeling was that one should add back only interest relating to capital funding eg long term debt interest etc.
You should add back _ all _ interest, net of taxes.