Operations and Interest Expense

Hi All -

I just want to make sure I understand something correctly - interest expense is INCLUDED in the calculation of CFO but EXCLUDED from NOPAT?

As I understand it, interest expense is a financing cash flow and not an operating cash flow. So, when calculating NOPAT from NI we need to add back interest and taxes to get EBIT and then adjust for EBIT after-tax, a.k.a. NOPAT.

But then when calculating FCFF starting from CFO, we add back the after-tax interest expense (because it was subtracted out from revenues, etc., to begin with).

This seems to conflict. If interest expenses fall under operations then they should be included in NOPAT and CFO. If they fall under financing then they should be excluded from NOPAT and CFO. It seems NOPAT excluded interest expense but CFO includes interest expense.

My apologies - I’m sure I can figure this out with some research but time is of the essence. Any help is much appreciated.

Interest expense is a CFO for US GAAP

Interest expense is a CFO or CFF for IFRS

Cool. What about net operating profit after tax (NOPAT)? Let’s stick to US GAAP where there is a clear cut designation that interest expense is a CFO. Why does NOPAT equal EBIT(1-t) if interest is an operating expense? … Just because … ? Just trying to figure out best way to keep this straight.

My understanding is that, since you are using WACC in the calculation of NPV, you need to remove the interest expense, otherwise you would be double counting the cost of debt.

It makes sense that a project should be discounted back at its WACC, because that is the source of funds. And it makes sense that the profit from the project should not include the interest expense, because inclusion of interest would - as EQ pointed out - be double counting interest. (Side note, when you say “calculation of NPV” you are referring to the economic value added calculation, right? Because the NPV of a project or firm is based on cash flows)

I guess at this point I’m just complaining more than asking and should probably move on. I was just pointing out that if interest expense is an operating cash flow then is should be subtracted from EBIT when calculating net operating profit after-tax. I would expect NOPAT to be NI minus any income statement effects from CFF and CFI.

Thanks all for the help. I appreciate it.