Hi, just posted this here not on level 2 as it’s more of a general thing. Can anyone please clarify to me the following: I saw some research analysts to calculate EV via FCFF, where they calculated FCFF as 1) FCFF=EBIT-[TAXES FROM INCOME STATEMENT]+NC-CFCinv - WCinv whereas we all studied that 2) FCFF = EBIT(1-T) + NCC - FCinv - WCinv so basically in the 1st variant an analyst lowers taxes as the tax base is [EBIT-interest] and the total folmula converts to FCFF=EBIT- [EBIT-interest]*(1-T) +NC-CFCinv - WCinv What are your practices? Is it correct in Excel to link taxes to FCFF calculation from income statement directly or it’s better to use EBIT(1-T) way? Or maybe a tax rate in EBIT*(1-T) is considered “effective”, not regulatory like in [EBIT-interest]*(1-T) and in the end we should get the same? Thanks!
Are you building a DCF model? If you are looking at historically reported FCFF, then you’d use whatever the real figure was. In forecasts, you’d use your assumption for the effective tax rate no? If you’ve built out an income statement with forecasts for the next few years, then I’d use those numbers for your DCF. Eventually you will have to just put in 40% or whatever for you terminal value. I hope that’s some help and I haven’t picked up what you’re saying wrong.
I am looking at the future FCFF. For example, FACT vs PROJECTED: FACT for 2008: EBIT=1000 Interest exp = 400 EBT=600 Tax (20% in Russia - regulatory corporate profit tax) =120 So FCFF fact for 2008 1) FCFF2008= 1000-120=880 (ignoring other FCFF components), RIGHT? or 2) FCFF2008=1000*(1-20%)=800 Projected 2009 - assume same EBIT=1000 Interest exp = 400 EBT=600 Tax =120 1) FCFF 2009 = 1000-120=880 (ignoring other FCFF components) or 2) 1000*(1-20%)=800, or 3) use some effective tax rate, in our case 12% tp come up with 880 => 1000*(1-12%) In fact, some of the analysts go with variant 2 => 1000*(1-20%) for projected FCFF, some go with variant 1
I’d go with the 2nd method, EBIT(1-t)
I agree with kblade. NOPAT is supposed to show the after tax OP left for all stakeholders, hence you factor out interest payments. When there are no interest payments (i.e. no debt), NOPAT = NP. If you take the tax to be 120, then you are factoring in the tax advantage of making those interest payments, which is incorrect. Thus EBIT(1-t) is the way to go. I think that makes sense anyway unless someone wants to point out a flaw in my logic.
I think the effect on interest payments is an important consideration. For historical FCFF, I’d probably just subtract actual taxes paid. EDIT: and I’d be wrong… if I had no debt, my taxes would be higher. FCFF is supposed to be a number that doesn’t change according the amount of debt you have. [EDIT OFF] However, for projecting forward, it’s important to make sure that the tax shield on the interest gets incorporated correctly, as Carson mentioned. Probably it doesn’t make too much of a difference if you have your numbers already determined for the years going forward, BUT if you are using a spreadsheet and want to run different scenarios, you want to make sure that the taxes change with the change in assumptions about interest payment growth, etc. Usually the (1-T) formula will be more flexible in that regard.
I use NOPAT = EBIT*(1-t) as well