Why would this be added to the FCFF calculation? Isn’t the amortization of bond discount a non-cash addition to NI that should be subtracted when calculating FCFF, not added? If this was amortization of bond premium I would understand the addition, but amortization of bond discount I would think would be a deduction in the FCFF calculation.
Amortization and Depreciation - are part of the NCC - Non Cash Charges - which are first added before you remove stuff in calculation of FCFF.
I’m familiar with the addition of NCC to NI when calculating FCFF. I think I was just looking at it from the wrong perspective. If a bond the company issues is issued at a discount, using the effective interest rate method would mean that part of the interest expense on the company’s IS would be amortization of this discount (increasing par value owed as bond gets closer to maturity), which would make interest expense higher on the IS than what it is in reality. That’s why we have to add it back to FCFF
I am assuming the opposite would be true of amortization of a premium bond the firm issued, which would result in a lower interest expense on IS (according to the effective interest rate method) than what the company paid in reality due to the par value of the bond decreasing as it gets closer to maturity. In this case a subtraction from FCFF would be appropriate for this amount of premium bond amortization? Any confirmation on this would be much appreciated.
I assume your interpretation should be right and you should deduct the amortization of discount as it was previously added to IS while it is a non cash charge
where did you find this line?
An amortized bond is one where the discount amount being amortized becomes part of its interest expense over the life of the bond. If a bond is issued at a discount—that is, offered for sale below its par or face value—the discount must be treated either as an expense, or it can be amortized as an asset.
When you own a bond that you bought at discount then you amortize this discount annually which will be an addition to the interest income showing in the income statement, so your statement is absolutely correct if we are amortizing a bond bought at premium
I think we need to read where this line is stated i am sure there is something hidden we can figure out a solution with it
It was a Wiley question that asked for the FCFF. I deducted the amortization of bond discount instead of adding it. And I started to wonder why it was added back and not deducted. I was looking at it from the perspective of an investment of the company (not the other way around) in which interest income would be inflated by the amount of the amortization of the bond discount and thus would need to be deducted. It’s from the opposite perspective (firm issued the bond) this interest expense was inflated by this amount but not actually paid out, thus adding it back.