Free Cash Flow

Has anyone reached this section yet? Any idea on how to memorize these formulas? They are all alike, and there are lots of them. Usually, some repetition is enough, but I don’t think it will work in this case. Let me know how you are tackling this.

Start with: FCFF=NI+Depr+Int(1-T)-FCInv-WCInv Now remember NI = [EBIT-Int]*(1-T) substitute FCFF=EBIT(1-T)+Depr-FCInv-WCInv -Int(1-T) + Int(1-T) cancels out. Then on to: CFO=NI+Depr-WCInv So FCFF=CFO+Int(1-T)-FCInv FCFE=FCFF-Int(1-T)+NetBorrowing (is all you need) I am writing this all from memory … so pardon me if any mistakes have been made in transcription - but you should get the general idea.

The intuition for me was also to bear in mind the investor class that the cash flows were flowing to. FCFF is before debt costs, but we must net off capital reinvestment in order to maintain future cash flows from our asset base FCFE are cash flows to the equity class so that is a post leverage metric and we include net borrowings since we can do what we like (in theory) with money from new borrowings, i ncluding pay dividends. CFO alternate method of course already includes the addition of the non cash charge and working capital investment, it has netted the taxes and interest so we must add back the after tax interest costs EBITs a b4 interest and tax metric so we tax effect ebit add back the NCC for FCFF EBITDA we have removed the tax shield of depreciation so we do the above and then add back tax affected depreciation charge as well Voila. The intution started after working alot of problems though. The first 2-3 times through it was mentally taxing, and a real pain the a$$

Dare I say it, but memorising the formula may just get you into trouble…FCF concepts come up in other areas of the curriculum… For L2, you do need to understand where the components come from and reasons for the difference between FCFF & FCFE, for example.

Think about it intuitively and then the formulas are easy. FCFF is cash flow generated to all stakeholders in the firm, both debt and equity holders. FCFE is cash flow to equity holders only. Do a couple of examples - it will start to make sense. These are easy points in the equity section as the material/logic is straightforward.

This of bit from the highest Level and Break it down: For Example, First on Cash flow: At high level WC Inv could be given in a problem one level down is broken down to Rev. Inv. and Pay one more level down they could give you working capital days and haveyou get to $change in inv. Same goes with P&L: First level NI, break it down NI = [EBIT-Int]*(1-T) this can go even broken down to Sales, COGS, etc… It’s worth spending some time how the P&L, balance sheet and Cash Flow is broken down. It’s an investment that will definitely help u on D-Day And as Perdition points out…you will see this topic in subsequent readings.