1st question on CFAI in reading 41 says “indicate the effect on FCFF and FCFE” of a change in $100 increase in depreciation. Tax rate is 40%. Answer says +$40, but from the equation, it seems like we just simply add the amount of depreciation. Also in many questions we just add depreciation amount. Why in this case it’s only the taxable amount of $40? I thought that’s only the case with FCFF calculating from EBITDA.
For a given increase in depreciation, you are only receiving the tax shield of the depreciation in actual cash savings.
But in question 2, there is a $180 in depreciation on Income Statement, and they simply added $180 for FCFF&FCFE?
Put up an example Sales 1000 COGS 500 Depr 100 No other expenses, 40% Tax NI=400*(1-.4)=240 FCFF=240+100=340, same applies for FCFE as well. Now say Depreciation went up to 200 NI=300*.6=180 NI Went DOWN 60 FCFF=180+200=380 FCFF Went UP 40
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Thanks CP.