Hi All, Just wanted to double check on this as I have seen a few contradicting posts…
For FCFE/FCFF If we have an amortization of bond prem on the Balance Sheet, we would REDUCE free cashflow values and if we had an ammortization of a discount we would INCREASE free cashflows. Is that correct?
Yes.
And for deferred tax assets we reduce. For deferred tax liabilities we add; however, watch out if they tell you these amount (i.e DTL) are expected to be reversed in the near future.
Yeah, I was rather confused about this initially. I still might be, but here’s the scoop as I understand it:
The answer depends on whether the bond is an asset (investment) or a debt of the company. If you’re amortizing premium on an asset, you’d be decreasing your interest income and if it’s a liability you’d be reducing your interest expense. If the adjustment was to an asset you’d add back the amort (because you received more interest than you reported on the IS) and if it’s a liability, you’d subtract it (because you paid more than you’re reporting). Amortization of a discount would be exactly the opposite.
The Wiley reading says to subtract amortization of bond premiums so I think there’s an assumption that the amortization is on a liability. Amortization of a bond discount is added back.
I have an easier time remembering whether to add or subtract the amortization if I think in terms of the accounting journal entries that would be required, but if you’re not too familiar w/ accounting debits and credits, this wouldn’t be a helpful tip for you.
The more I think about this I think I was wrong originally If the asset you hold is ammortizing a premium, you are reducing your NI each period by a portion of that premium, BUT that is a non cash charge, so that should not impact your free cashflows available. I think based on that logic, a premium ammortizied is added back to NI when calculating FCFF/E and a discount is subtracted. S2000, can you take a look at this and double check the logic?