FCFF & Divs/Debt

CFA Level II Equities
#1

There was a question in one of the mocks about the effects of company’s FCFF with issuance of new debt and establishment of a new dividend.

I know dividends don’t affect FCFF, but I thought new debt would since we add back the after-tax interest expense (Int exp* (1-T)) to NI (or CFO depending on what’s given). In other words, more debt issued -> higher interest expense.

The answer says neither has any effect on FCFF. And of course, Schweser’s answer explanation simply repeats the question and answer.

What’s the story here? Thanks!

#2

The higher after-tax interest expense is included in NI so when you add back the interest expense, you eliminate the change in NI.

#3

got it, thanks!

#4

Instead of calculating FCFF (at least the first part) as NI + Interest, use the alternate formulation of EBIT x (1-t). Remember - FCFF is the cash flow that is distributable to either creditors or owners (debt or equity). So, it’s calcualted on a “pre fininancing” basis.