FCFF calculations

CFA Level II Equities
#1

Hi everyone,

I’m currently working on a valuation assignment and I have some misunderstanding with my colleague as to how FCFF is calculated.

Take this example:

Revenues : 100$

OpEx: 50$ (and let’s say there’s no depreciation)

-> EBIT=50$

(-) Interest : 20$

-> EBT = 30$

(-) Tax @ 10% : 3$

-> NI = 27$

According to CFAI and all other sources, then FCFF = NI + Interest * (1-tax) = 27 + 20 * (1-10%) = 45$ and FCFE = 27$

Now if I take the above P&L statement and I check how much money shareholders and creditors will have to share at the end of the year, I could also say that at the end of the year, they will need to share among themselves 27$ + 20$ = 47$ (FCFF) as the taxes of 3$ have already been paid in. Creditors will get their 20$ interest in cash and shareholders will remain with 27$.

So there’s a 2$ difference between the FCFF calculated by the formula and the one calculated on humble common sense. How is that possible?

#2

tax shield on the interest?

#3

agreed, tax shield on interest.

#4

sure it’s tax shield, but why does it diminish FCFF, the cash available for both shareholders and creditors?

#5

The idea is to “unlever” the company.

So assume the firm has no debt. If it has no debt, then it doesn’t make that $20 interest payment.

If it doesn’t make that $20 interest payment, the firm will make an additional $20 of profit.

The firm will pay $2 in taxes on that additional profit (so the $2 is not really available to the creditors or shareholders).

#6

Ok, but in reality how much money this company has at the end of the year? 45 or 47$? Why not 47$?