hello everyone

i would to ask in FCFF formula we add NI+ Int(1-tax%)

If we want to calculate the available cash for lenders why we treat the interest expense as it taxable, if i paid $1000 as an interest expense it’s not taxed and the full amount paid to the lenders, so why I calculate it after tax if i want to calculate the cash available for the lenders

Because when we deducted it in calculating net income we had lower taxable income so we saved money on taxes.

As if there weren’t any borrowing, we would have saved on the interest - hence we add.

Though, if we had higher income - we would have paid higher tax as well.

Thus, when we add interest, we also have to deduct additional tax.

Alternatively, we just add the net !

Considering you have not given the entire FCFF formula, I am just focusing on the part you mentioned.

Basically, the way I understand, the part of the formula which you have given involves reverse calculation of NOPAT.

The term **NI + [Interest x(1- t)]** gives us NOPAT which can also be calculated as **EBITx(1 - t)**

Consider this example,

Earnings before Interest and Taxes (EBIT) $1,000

Less: Interest $ 400

Earnings Before Taxes $ 600

Less; Tax @ 30% $180

Earnings After Tax(NI) $420

Method 1: I can find NOPAT by EBIT x (1-t) = $1,000x(1 - 0.3) = $700…[EBIT is the profit of all funding parties of the company]

or

Method 2: I can find NOPAT by NI + [Int x(1-t)] = $420 + [$400 x (1-0.3)] = $420 + [$280] = $700

the same answer.

So if you understand the logic behind, we are never actually deducting interest or after tax interest in the 1st method, we are only considering profit of all funding parties on an after tax basis which is NOPAT.

In the 2nd method as NI is already an **after-tax figure** we have to add an **after-tax interest** to properly reverse calculate NOPAT.

If someone adds only Interest instead of an after-tax interest it won’t be logical and the answer won’t match.

Hope this answers your query. Cheers !