# FCFF question

We know that depreciation expense is added back to calculate FCFF as a Non Cash Charge. As I was going through Stalla’s Passmaster, I got thrown for a loop. In the question, they add depreciation expense as part of the Fixed Cost Investment thereby negating depreciation expense. In the answer NI=\$150,000 NCC=\$20,000 (depreciation expense) Int=\$18,000 FC Inv= \$50,000 (change in net fixed assets) + \$20,000 (depreciation expense)=\$70,000 WC Inv=\$20,000 Their answer is that FCFF=\$98,000 Shouldn’t FCFF=\$118,000? Why is depreciation expense included in FC Inv? They just cancel out so depreciation is not truly factored into the equation. \$118,000 is one of the possible solutions. Is this just an error on Stalla’s part? I sent them an email, but I’ll get a much faster repsonse here. For those of you using Stalla, its question #01195. Or you can find it in SS 12, Free Cash Flow and RI Valuations (#8 of 44) Thanks.

sometime question says that FcInv - Dep = 0. Post the full question.

I think there has to be a clause saying something like this. We need the whole question.

and tax rate for the interest expense… I see in some Q’s where they state that Deprec and FC are expected to offset one another.

Tyco Company Balance Sheets (\$) 12/31/20x0 12/31/20x1 Cash \$100,000 \$180,000 Accounts Receivable - 70,000 Inventory 50,000 50,000 Next Fixed Assets 400,000 450,000 Total Assets 550,000 750,000 Accounts Payable \$40,000 \$90,000 LT Debt 400,000 400,000 Contributed Capital 110,000 110,000 Retained Earnings - 150,000 Total Liab. and Equity \$550,000 750,000 Income Statements () 12/31/20x1 Sales \$500,000 COGS (200,000) Depreciation (20,000) EBIT 280,000 Interest (30,000) Pretax Income 250,000 Taxes (100,000) Net Income \$150,000 Other information: in 20x1, Tyco company sold no fixed assets. Tyco’s long-term debt comes due in 5 years and no principal payments were made in 20X1. Based on the above financial information, Tyco Company’s free cash flow to the firm in 20x1 is closest to: a) \$80,000 b) \$98,000 c) \$118,000

I have also seen some questions where they say the company will go out of business or liquidated after say 4 years, and then for the RI valuation, we have to assume that the BV comes to zero, by passing out the entire net income earned in that period as dividends (liquidating dividends) so that there is no retained earning and hence the the continuous RI is also 0, then on. Crap now I don’t know where I saw that…

Sorry, the format didn’t take. The answer is as I mentioned above b) \$98,000 From the answer: NI \$150,000 (got that) NCC=\$20,000 depreciation expense (got that) Int (1-tax rate)=Interest expense (1-tax exp/pretax income)=\$30,000 (1-100,000/250,000)=\$18,000 (got that) FC Inv.=change net fixed assets + Depreciation=\$50,000 + \$20,000 (this is where I don’t understand adding depr. back) WC Inv=Change AR +change Inv- Change AP= \$70,000+0=\$50,000 (got that too) So, its the addition of Depreciation to FC Inv that is getting me. I didn’t see anything in CFA guide or Stalla guide about including depreciation to FC Inv. Plus, the figure I come up with is one of the possible solutions.

I get 118k too…that deprec seems messed up to me.

see now it all makes sense. FCFF(2001) = NI(2001) + NCC + INT(1 - TR) - FC - WC FCFF = 150 + 20 + 30(1 - 100/250) - [450 - 400 + 20] - [(70-0) + (50 - 50) - (90-40)] FCFF = 150 + 20 + 18 - 70 - 20 = 98 = Ans B

tvPM Wrote: ------------------------------------------------------- > I get 118k too…that deprec seems messed up to > me. That’s encouraging to me. FCFF/FCFE and RI are not my strong suits and just when I thought I was getting it…WHAM! I’m hoping others also find it to be an error.

The FC investment has to be gross differential - so to go from net to gross you need to take into consideration dep for that year. So adding back 20K to the delta(FC) will give you gross delta(FC) which we plug and chug and get a winner B

I dont see anywhere where it sas it is a Net FC investment. I saw Next Fixed Assets…is that supposed to be Net Fixed Assets??? That did look weird to me, but I see weird stuff all the time.

tvPM Wrote: ------------------------------------------------------- > I dont see anywhere where it sas it is a Net FC > investment. I saw Next Fixed Assets…is that > supposed to be Net Fixed Assets??? > > That did look weird to me, but I see weird stuff > all the time. Typo on my part. It should have read Net, not Next.

you sonofa!! Making me look like a fool in front of everyone!!! good catch swaption, makes sense.

swaptiongamma Wrote: ------------------------------------------------------- > The FC investment has to be gross differential - > so to go from net to gross you need to take into > consideration dep for that year. So adding back > 20K to the delta(FC) will give you gross delta(FC) > which we plug and chug and get a winner B Ok, so if the balance sheet says “net” fixed we include depr. exp to FC Inv? Thus (in Peter olinto voice), if it did not say ‘net’ then the answer would be c) \$118,000?

Depreciation is only added if it is reinvested into PP&E. Maybe maintenance / replacement of old equipment… Question does not clearly mention this though … Am I missing something ?

Nopes. Its added to get back to the gross amounts.

Ok… thanks Great trap and spelling mistake was even bigger trap Net PP&E (2001) = Gross PP&E (2001) - Accumulated Dep(2001) – (1) Net PP&E (2000) = Gross PP&E (2000) - Accumulated Dep(2000) – (2) If no assets are sold, we should have FCInv = Gross PP&E (01)- Gross PP&E(00) from (1), (2) FCinv = Net PP&E (01) + Acc Dep (01) - Net PP&E(00) - Acc Dep (00) = Net PP&E (01) - Net PP&E(00) + [Acc Dep (01) - Acc Dep (00)] = Net PP&E (01) - Net PP&E(00) + Depreciation Expense. This what we have done…

to piggy back on swap you always use change in GROSS Fixed Assets in FCFF / FCFE problems. If Net is given, you have to make it GROSS as follows - Beginning Net Fixed Assets - Asset Sales + Depreciation +/-change = Ending Net Fixed Assets So in this example, 400 -0 +20 +/-30 =450

Thanks everyone. I think my sanity is returning. I needed that b/c I gotta get to an interview.