- Why is the single stage FCF model useful for stable firms in mature industries? 2)Why is NI considered a poor proxy for FCFE? 3) Why is EBITDA poor proxy for FCFE? 4) WACC is always less than ROE…Why/How? 5) DTL is added back to NI ti compute FCFF…Why? Thanks in advance!
- Mature industry + stable firm - this combination - has their fixed capital and working capital needs kind of sorted out. Only maintenance spending would be happening, esp. on the fixed capital side. Also there would not be wild fluctuations in the CFO for the firm. Given these - FCFF would likely be a steady number, growing at approximately the growth rate of the industry - and can be used to value the firm well. 2) FCFE=NI + NCC (Depr) - FCInv - WCInv + Net Borrowing Depreciation ignored, fc investments and working capital investments ignored when NI is used. So if the co. is a growing company - it might be borrowing a lot, as well as making fixed cap. and wc investments - which would not be counted. 3) FCFE = EBITDA(1-T)+Depr(T)-FCInv-WCInv+Net Borrowing. Same items as in the Net Income statement above. Also EBITDA is a pre-tax measure. FCFE is post-tax. 4) WACC < ROE ROE should be greater than Cost of common equity for a company to have profitable projects generally. WACC < Rce -> since wd*rd*(1-T)+wce*rce = WACC. So ROE > rce > WACC --> should be the general rule. 5) DTL usually arises because of differences in the treatment of depreciation between financial reporting and tax reporting. [straight line depreciation for book and accelerated depreciation for tax.]. However - if the DTL is expected to reverse in the near future - ignore DTL changes. A growing company incurs more DTL [more capital, more depreciation] quicker than the reversal would occur. In these cases - change in DTL is added to compute FCFF.
Thanks CP