When solving for FCFF using the NI Method, Schweser says to add Preferred dividends back into the equation (Reading 42, Question 6, Answer explanation). Similarly, when solving for FCFE from FCFF you are supposed to subtract the Preferred Dividends. Can someone explain why this is done?
preferred dividends is paid to preferred shareholders. So you add it back to FCFF - because that amount is effectively available to common share holders - and FCFF is a measure of available cash flow to common shareholders. Professor’s note at the end of page 206 explains this: Treat Preferred stock just the same as Debt - except that it is not tax deductible.
Makes sense. Thanks.
So I imagine that you would substract it when working youre way back to FCFE?
yes, you would but without the tax benefit thing you do with Interest. FCFF = CFO + Int (1-T) + Pref Dividend - FCInv FCFE = CFO - Int (1-T) - Pref Dividend + Net Borrowing