# Help on valuation formulas

1 ) When calculating FCFF from EBIT or EBITDA, why don’t you add the interest tax benefit? Especially since the EBITDA derivation adds back the depreciation tax benefit. 2) For the formula to predict FCFE with a target D/A, why do we deduct depreciation from capital expenditures? Any help is appreciated, thanks.

1. because it is already in the calculation. EBIT stands for Earnings before interest and taxes. You multiply by (1-t) and are left with “EBI” earning before interest (is deducted), thus the interest is already in the value. Same with EBITDA just taking out the DA first 2) not sure… I actually can never remember that equation, if you could post it would be helpful…As I remember, you are not so much deducting it, but insteading finding the difference between the FCINV and Depeciation. Could be way off on this though

Thanks rekooh, Per #1, doesn’t EBIT(1 - t) result in a higher taxable basis? In reality, the tax should be reduced by Interest * t. For #2, you are right that the formula looks for the difference between FCInv. and Dep. I was thrown off by the - dep. in a cash flow problem. The formula is NI - ((1 - D/A) X (FCInv. - Dep.) - (1 - D/A) X (WCInv.)).

thought NI = (EBIT- I)(1-t) = EBIT (1-t) - I(1-t) (*) FCFF = NI + NCC + I(1-t) - FCinv - WCInv (**) substituting (*) into (**) FCFF = EBIT(1-t) + NCC - FCinv - WCInv

nyfinance Wrote: ------------------------------------------------------- > Thanks rekooh, > > Per #1, doesn’t EBIT(1 - t) result in a higher > taxable basis? In reality, the tax should be > reduced by Interest * t. > > For #2, you are right that the formula looks for > the difference between FCInv. and Dep. I was > thrown off by the - dep. in a cash flow problem. > > The formula is NI - ((1 - D/A) X (FCInv. - Dep.) - > (1 - D/A) X (WCInv.)). The CFAI books make a key point here. You are right, by having a higher taxable basis you lose interest tax shield, HOWEVER, the tax shield is already reflected in the WACC used to discount as WACC uses after tax interest costs, including the interest tax shield in your cash flows double counts this impact and can increase your value. For instance the book goes on to make the point that if you were to use a discounted EBITDA measure as some firms do (which the books point out is weak and erroneous compared to FCFE AND FCFF) you should use PRE-TAX WACC for discounted EBITDA measures as the cash flows are pre-tax. To do this you would use pre-tax cost of debt and gross up your cost of equity in similar fashion. The moral of this story is always make sure your discounted rate accurately reflects what you’re discounting.

For #2 New Borrowing = D/A X (FCInv-Dep) + D/A X WCInv FCFE = NI + Dep - FCInv - WCInv + New Borrowing = NI - (FCInv - Dep) - WCInv + New Borrowing = NI - (FCInv- Dep) - WCInv + D/A X (FCInv-Dep) + D/A X WCInv = NI - (FCInv - Dep) X (1-D/A) - WCInv X (1-D/A)