Price/Cash Flow Ratio

Is my CF computation below correct?

Net income per share=$8 Price per share=$200 Depreciation per share=$4 Interest expense per share=$3 Marginal tax rate=35%

CF = [8/(1 - 0.35) + 3 + 4] - (8/0.65 - 8) = $15

Therefore, P/CF = 200/15 = 13.33

It depends on what CF is referring to: FCFF (free cash flow to firm) or FCFE (free cash flow to equity).

In this situation (note that there is no CAPEX or change in working capital given), if CF = FCFF

FCFF = Net income + non cash charges (ie, depreciation) + after-tax interest expense

FCFF = 8 + 4 + 3(0.65) = 13.95

Note that we added back the after-tax interest expense because FCFF is cash flow available to stockholders and bondholders. Therefore FCFF is pre interest.

If it’s FCFE, you can ignore the addback of the after-tax interest expense.

FCFE = Net income + non cash charges (ie, depreciation)

FCFE = 8 + 4 = 12

Now you can calculate your P/CF ratio based on either of those two, depending on whether the question specificy it’s free cash flow to the firm or free cash flow to equity.


Or something else.

Hi. The CF I’m referring to is CFO. In that case, I hope my computation is correct, is it not?

It’s incorrect. If It’s CFO, you do net income + depreciation

CFO = 8 + 4 = 12

In most cases CFO = net income + NCC (eg, depr & amor) + change in net working capital

CFO is after your interest expense, but you want to add back your deprecation because deprecation is a non cash charge. Does that make sense?

Yes. Thanks for clarifying that. Much appreciated.

Shouldn’t we be adding the interest expense back as well as it is a non-operating expense? What is the rationale behind not adding it as well?

US GAAP treats interest expense as a non-operating expense, but cash interest paid as an operating cash (out)flow.

There is no rationale; it’s just stupid.

That’s crystal clear! Thanks!