Your interest burden also increases, but since that isn’t captured in fcff, then we can’t assume that debt issuance and repayment is part of free cash flow, to keep consistent. We assume that any new debt will be used on capital expenditure, and not more cash available to claimholders. It does count towards equity however.
I would think that it is not included because you will have an offsetting liability that the debt hodlers have claim too. So it would be redundant to include cash available in FCFF when you would subtract it because it is also money owed. We do include the interest cost however, because debt holders have claim to the cash flow before the itnerest charge is made.
After tax interest costs are added back to net income because FCFF is cashflow available to all claimholders. Debt is a liability and not a source of residual cash. For equity cash flows, we remove the claims of debt holders and are left with cash flow after paying interest but before common dividends, net debt issuance is also part of FCFE because debt is a different source of financing, and can be used to pay off claims to shareholders by changing the capital structure. Just as FCFF does not include reciepts from raising equity.
Someone correct me if I’m wrong, I haven’t read L2 yet.
Think of it this way: We use the metric (FCFF) as a means to identify how much cash flow is being GENERATED by the firm that is available to the suppliers of capital (debt holders and equity holders). Therefore we start with net income, because this represents earnings generated by the firm, add back in non-cash items because things like depreciation are subtracted from NI but are not actually cash outflows, add back in after tax interest because this is cash that went to debt holders and we want the metric to show us cash before any suppliers of capital receive our cash flows, and finally subtract our FCinv (capex) and changes in working capital because they do not flow through to NI on the income statement but they are cash outflows necessary to run the business and therefore are not free cash flows available to suppliers of capital.
You’re not wrong in your statement that the cash raised from a debt issuance is technically available to be paid out to debt holders and in fact this happens often for refinancings etc, but the metric is structured to show the cash flows generated, for lack of a better term and for all intents and purposes here, organically or through the firm’s primary business activities.
I would have to disagree with the reasoning here, it is more simple than this. Debt issuance is not excluded because of any balancing or offsetting effects, but rather because FCFF focuses on the cash flow generating abilities of the firm via its operations, hence why we start with net income. After tax interest expense is added back to NI because it is NI is calculated net of interest and because we want the figure to be representative of the cash flow that is available before any suppliers of capital receive payment.