What is the appropriate treatment for preferred dividends when calculating FCFF and FCFE? Is Pref Div added to NI when calc FCFF (I thought NI was supposed to be NI avail ONLY to commonshareholders as I recollect from the book, but then upon another reference it said pref dividends should be ADDED to NI when calc FCFF so im reallllllllllllllllllllly confused), and added to “Net Borrowing” when calculating FCFE (since it is additional borrowing)? Please help - Thx!
FCFF is cash flow for everyone, including those rich folks who own the pref stock. So, to compute FCFF you need to include any dividend that you pay them, just like you add interest to FCFF because it belongs to the total cash flow of the company. When you look at FCFE (equity) you are looking at the cash flow which belongs to those who provided equity to the company, including those rich pref stock folks. Here what you are adding is not the dividend, rather any financing (cash) you may have received from the pref guys, if they were issued any stock. Let us say for this year you issued pref stocks of $100 million. That’s cash flow that was pumped into the company (added to net borrowing) but it only belongs to equity holders, not debt holders.
Preferreds are added back to NI to get FCFF, as it is the fcf available to all capital providers. They are taken out for FCFE, as that is the fcf to equity holders. Your question relates to the calculation of NI, or sounds like, and preferreds are taken out to get to NI. NI is bottom line, after all debt and preferred holders are paid. So for FCFE, the NI number already accounts for preferred divs paid. No adjustment needed.
maybe im getting the preferred stock issuance/redeemed mixed up with preferred stock dividends…
yes. preferred stock dividends are added back when calculating FCFF but taken out when calculating FCFE as bondholders get paid before preferred shareholders and common equity holders get paid after preferred holders.
FCFF = NI + NCC + INT(1-T) - FC - WC + PREF DIV VALUE OF EQUITY IS TOTAL FIRM VALUE LESS VALUE OF DEBT AND PREFERRED STOCK EQUITY VALUE = VALUE OF FIRM - MV DEBT - PREF STOCK
Treat preferred stock like debt, except preferred stock are not tax-deductible. Preferred dividends are added back to FCFF. This is assuming that Net Income calculated is to equity shareholders after dividends have been subtracted out. FCFF = NI + NCC + Int(1-tax rate) + preferred dividends - FCInv - WCInv The only adjustment to FCFE would be modify net borrowing to reflect new issuance by the amount of preferred stock. FCFE = FCFF - Int(1-tax rate) - preferred dividends + Net borrowing + Net issuance of preferred stock http://www.analystforum.com/phorums/read.php?12,1132255