If we are told that FCFF is 0.5m and we assume an increase in interest expense of 200,000 with a tax rate of 20%. What impact do we expect to see on FCFF?
I was thinking that because the formula is FCFF = NI + INT (1-T)
Then surely the FCFF number would increase.
The solution says there is NO impact on FCFF.
I understand this as FCFF is after interest expense, so there should be no impact but whatabout if we look at the formula. Wouldnt that number increase?
because NI also goes up/down by the change of int(1-t)
No impact because in FCFF you only have to add back interest * (1-T) because you have previously deducted it if you started from NI.
rule of thumb, FCFF IS NOT impacted by leverage. if the company issues new debt, FCFE will increase, but FCFF stay the same
Even if netted by tax, but we still do add, right…
Also, logically thinking, we add it because it’s a cash flow available to all capital providers. So shouldn’t it increase FCFF…
No, because FCFF is the Free Cash Flow to all providers of Capital (Equity and Debt providers) therefore, a change in interest expense should not matter, as FCFF is before any distribution to Equity and Debt providers is made.
But we do add it back to arrive at FCFF
Remember NI is the bottom line in the Income Statement, so interest expense changes are included in NI.
The net effect is 0 on FCFF.
This seems very testable (along with the 5 billion other trick questions I’ve encountered so far)