FCFF and NCC

CFA Level II Equities
#1

Hi can someone please help on the formula for FCFF?

FCFF = NI + NCC + Int (1-t) - WCInv - FCInv

My question is why is it that NCC is included as NCC and not net of tax ie NCC (1-t)? The NCC (such as depreciation) should add a tax shield similar to interest?

Thanks in advance!

#2

Because NI is already after depreciation and the tax benefit, you add it back. Here’s the math: (D=NCC) Fcff = (Ebitda-D) (1-t) + D - Wcinv - Fcinv = Ebitda(1-t)+DT - WCinv - FCinv NI= (Ebitda-D-I) (1-t) = Ebitda (1-t) - D + DT - I(1-t) To proceed to fcff from NI, the common terms can be ridden/canceled out which are: Ebitda(1-t) + DT You’re left with -D - I(1-t) which aren’t part of the above fcff formula, so add them back. Effectively its like saying it’s NI without these terms, that is Ni + D + I(1-t) minus Wcinv and Fc inv

#3

Because you have to adjust NI for all non cash charges to calculate FCFF which is a pure cash flow.

If you compare this first formula starting with NI with another based on CFO you will find that in another one you shouldn’t make an adjustment for non cash charges which impact corp earnings (NI) but not cash flow from operations.

For better overral understaning, you should practice and try to understand movement by comparing all FCFF and FCFE formulas at once not just concentrate to isolated one.

#4

And Interest doesn’t feature in fcff calculation.

#5

Thanks for the respones

Looking at the formula provided by AmruthSundarkumar:

Fcff = (Ebitda-D) (1-t) + D - Wcinv - Fcinv Why is it that interest is not deducted from EBITDA and then subsequenlty added back since interest also provdes a tax shield, similiar to NCC (like depreciation)? Fcff = (Ebitda-D - I) (1-t) + D + I - Wcinv - Fcinv Think that would be an important part of undering the intial question Thanks again to all

#6

Since EBITA is operating result before interest and depreciation we cannot add back something which is not deducted prior (as in Net income). You have only adjustement for tax effect on depreciation by multplying effective tax rate with depreciation expense, thus correct formula

is not Fcff = (Ebitda-D - I) (1-t) + D + I - Wcinv - Fcinv

than

FCFF = EBITDA(1 - T) + (D x T) - FCINV - WCINV

#7

Fcff is for the firm, deducting interest will amount to cash flows to the equity holders (fcfe). Secondly the effect of having debt (and therefore interest/coupon payments) gets reflected in the cost of capital (cost of equity+cost of debt). The effect of deducting interest and benefiting from its tax shields etc will feature when calculating fcfe - where the discount factor is cost of equity.

#8

And yes, interest won’t be added back while calculating fcfe because it is a cash expense unlike depn which is not a cash expense.

#9

You’re correct that interest isn’t added back when calculating FCFE, but you’re mistaken about the reason.

It’s not that it’s a cash expense; it’s that interest is a necessary payment to creditors, so that money does not belong to shareholders.