when a company issue debt to pay dividend, what is the effect on FCFF? Doesn’t FCFF increase due to increase in interest?
yes, if the debt was issued on the first of the year so as to get the benefit from paying/accruing interest all year long. NI + Int(t-tax)+WCinv+FCinv= FCFF
FCFF will increase because the Interest(1-t) will increase FCFF = NI + NCC + Int(1-t) - FCinv - WCinv
then how do you explain this? Q. when company X establishes a dividend and issues additional debt, most likely effect on FCFF be: A. no change B. FCFF decrease C. FCFF increase correct answer is A according to schweser. vol 2 exam 2 question #39. can someone shed some light on this?
Because NI drops by the same amount as the increase in Int(1-t). INT(1-t) is an addback
right i see… forgot about that… thanks ramdabom.
I’m just reviewing this section now, but if FCFF = CFO - Capex, wouldn’t the additional interest paid lower CFO? … never mind, I think I got it from the above.
So is the conclusion, no FCFF does not increase from issuing additional debt.
FCFF = CFO + (1-t)interest - FCInv.
But isn’t interest and taxes operating cash flow? only principle repayments are financing. So CFO-interest paid+taxes on interest + (1-t)interest-FCINV So no impact?
It has no effect. Just do a simple scenario analysis (simplified to ignore WCInv, FCInv and NCC since they aren’t relevant — and we all know dividends dont impact FCFF or FCFE): Before issuing debt to pay dividends: EBIT = 50 Int = 10 EBT = 40 Tax (@20%) = 8 Net Income = $32 FCFF = Net Income + Int (1 - tc) + NWInv + FCInv + NCC FCFF = 32 + (0.8)*(10) + 0 + 0 + 0 FCFF = $40 Now I issue $100 in debt @ 10% to pay dividends: EBIT = 50 Int = 20 [10 + (0.1 * 100) = 20] EBT = 30 Tax (@20%) = 6 Net Income = $24 FCFF = Net Income + Int (1 - tc) + NWInv + FCInv + NCC FCFF = 24 + (0.8)*(20) + 0 + 0 + 0 FCFF = 24 + 16 FCFF = $40 Voila.
I don’t really understand the need for so much of discussion here and the calculations as well. It’s obvious that dividends or debt payments/issuances won’t affect FCFF since it’s a pre-levered cash flow measure. There’s no need to check if it through the formula by adding int(1-t) to the net income. It’s simply the fact that FCFF does not account for interest or dividends. Whereas FCFE, is a post-levered measure and hence accounts for interest and net borrowings(debt payments or issuances). Dividend however, is a payment that can be made from FCFE, so it does not affect FCFE. Only leverage would affect FCFE and the effects would be opposite in the year of issuance and subsequent years. If you issue debt today, FCFE increases because net borrowings increase. Future FCFE decreases because interest payments increase. It would be the other way for debt repayment.
Anything that is a use (or in other words NOT A SOURCE) of FCFF/FCFE will not affect the FCFF/FCFE. 1) Increase common stock dividends