Interest rate tax shield when using EBIT/EBITDA for FCFF

  1. FCFF = NI + INT (1- tax rate) + NCC - FCInv - WCInv
  2. FCFF = EBIT (1- tax rate) + DEP - FCInv - WCInv
  3. FCFF = EBITDA (1- tax rate) + DEP (tax rate) - FCInv - WCInv

I can mathematically get from 1 to 2 to 3.

However, can someone please help explain how interest and depreciation are treated differently here? I am struggling to wrap my head around it. Where depreciation is included (1 & 2), the depreciation is added back as a NCC – makes sense. The tax shield is retained. However, isn’t the goal to do the same for interest: retain the tax shield but add the interest back as it is available to the firm and should be included in FCFF? I know this is wrong but my intuition tells me the interest expense should be added back without (t- tax rate).

Also, isn’t there an interest tax shield not included in #3?

Anyone able to explain in layman’s terms?

There is no need to add interest back in (2) and (3), since interest expense is included in EBIT. EBIT = Earnings before interest and tax. In (1), in order to get to NI, we had to subtract interest expense in the first place.

In (3), remember that D&A are non-cash expenses, interest expense is a cash expense on the other hand. That is why we add up the tax-shield “Dep*Effective Tax Rate” to get FCFF from EBITDA.

Ah, thank you Gurifissu. While understanding interest is in EBIT/EBIT, the piece I wasnt considering is that the goal is to add back All of interest expense and the tax shield. Since you want the cash available ignoring interest entirely. Depreciation you are still realizing the tax savings you are just adjusting because it is a NCC. Got it. Brain gets weaker as the days go on I feel.

itll be June 6 before we know it

thanks again