Revenue 100 Interest expense 10 Tax (30%) 27 NI 63 Using formula: FCFF=63+10*0.7=70 But I thought it should be 63+10= 73 instead? Why does we need to * (1-tax rate)?
One of the components of FCFF when starting from net income is Interest expense. FCFF is the cash flow available to all providers of capital. So, we have to add back the interest expense to NI. In a situation where you don’t pay interest, EBT is increased buy an amount equivalent to the interest expense and that amount will be subjected to tax. The amount available to distribute is reduced by the tax on interest amount.
so you mean that we assume the interest will be taxed at the same rate as net income?
maisatomai Wrote: ------------------------------------------------------- > so you mean that we assume the interest will be > taxed at the same rate as net income? Yes, I can’t think of any situation where it would be otherwise. Think of the interest deduction as a tax shield, all the formula is doing is removing that shield.
definitely need to know this formula. in fact, you should know how to calculate the FCFF number for multiple years and be able to discount it to a PV. got this right last year, got too many other ones wrong though…(Price of Right losing sound) Waaa Waaaaaaaaaaaa!
think of FCFF as pre-levered cash flow, therefore for all FCFF calculations, you need to add in after tax interest think of it as cash flow to the firm BEFORE bond holders are paid (interest expense) AND before equity holders…