Looking at a question here in the schweser notes that basically states the following: Analyst prepares a 10 year forecast of FCFF and FCFE from 2008 to 2017. In early 2008 the firm anounces an unexpected issue of new 15yr debt. The question asks, as a result of the unexpected debt issue, The analyst should most likely: A. increase his FCFF forecast for 2008 and decrease his FCFF forecast for 2009 through 2017. B. Decrease his FCFF forecast for 2008 and increase his FCFF forecast for 2009 through 2017. C. Not change his FCFF forecast for 2008 and also not change his FCFF forecast through 2017. Answer: C Shouldnt the answer be, Not change his FCFF forecast for 2008, and INCREASE his FCFF forecast through 2017 due to the increased tax shield (interest exp.* 1 - tax rate)?? FCFF year xx = NI + NCC + Int exp(1 - tax rate) - FCinv - WCinv

All else being the same, in the calculation of FCFF, you have to remove the effect of the tax shield [Int(1-tax)], Which reduces the FCFF for 2008 and ahead (the debt is issued early in '08). The answer would be B.

I’m not sure thats correct, in the example I give below, Assuming new debt is issued, that would make FCFF higher in the following year and if the interest payments started that current year, higher in that year as well. interest (debt) expense: 20 tax rate is: 40% NI: 40 NCC: 20 FCinv: 10 WCinv: 20 40 + 20 + 20(1-.40) - 10 - 20 = 42 interest (debt) expense: 40 (higher than year before) tax rate is: 40% NI: 40 NCC: 20 FCinv: 10 WCinv: 20 40 + 20 + 40(1-.40) - 10 - 20 = 54

you seem to have forgotten the impact of the higher interest expense in that it would have first reduced the NI figure - and then it would have been added back, all else being equal… here since the interest expense went up and the NI remained the same, something else has also changed to keep NI at 40…

with the new debt… NI is now lower by interest (1-t) interest (1-t) is added back to get FCFF (no change in FCFF) interest (1-t) is then subtracted out of FCFF to get FCFE so no change in FCFE Am I right?

June2009: I believe FCFE would be higher in 2008 and lower every other year b/c 2008 FCFE = FCFF - INT(1-tax) + Net debt [which increased in 2008] 2009 FCFE = FCFF - INT(1-tax) [Which increased b/c of new debt] + Net debt so, while FCFF has no effect from increasing debt, FCFE does. anyone else agree?

I guess they’re teaching you to back into FCFF from NI or other lower line on I/S? Working the other way: FCFF is roughly EBITDA less adjustments (including capex, change in WC, others). The operative phrase here is “Before Interest” – in keeping with the general stance that these figures are all about operating performance, and nothing about financing costs. So change in capital structure won’t affect such measures.

FinNinja - you are right I think. I didn’t add the net borrowings to get FCFE. Also didn’t read the ? correctly. If the question had asked what happens with FCFE: It would increase in 2008 from the net borrowings for 2009-2017 it would not change compared to what he originally forecasted (assuming no new debt or net borrowings)…meaning the (interest(1-t)) all cancel out, so FCFE for the remaining years is unchanged… ???

Question is NOT worded around FCFE , people. Its a simple FCFF question . FCFF is not affected by new debt issues . FCFE is increased by Net borrowings , but they are not asking about FCFE

No, future FCFE would be lower b/c the higher interest expence would lower NI. ie. FCFE = NI + Dep - WCInv - FCInv + Net Debt; when solving from NI. Since NI would be lower to begin with the whole equation would be lower in the end. the reason FCFF does not change is becaue you add back that larger Int exp. Take an example where Dep/WCinv/FCinv/Taxes all = 0; so basically a Co. that exists only to create debt! if: Before Extra debt: EBIT = 10 Int Exp. = 2 NI = 8 FCFF = NI + Int Exp(1-tax[0]); or 8+2=10 FCFE = NI (b/c all other inputs are 0); or 8 After extra debt: EBIT = 10 Int Exp. = 4 NI = 6 FCFF = NI + Int Exp(1-tax[0]); or 6+4 = 10 (same as FCFF above) FCFE = NI; or 6 (less than FCFE above)

^^^ Nice. Ok. I think I follow…