 # Stupid FCFF Question

Does FCFF = EBITDA - taxes - WCInv - FCInv? Given the following: EBITDA 100 NCC (10) EBIT 90 IntExp (10) Pretax Earnings 80 Tax at 20% (16) NI 64 WC&FCInv(10) If FCFF is cash available to firm after paying operating expenses and taxes, then FCFF ( EBITDA - taxes - WC&FCInv ) = 74 (100 - 16 - 10) However, I’m getting 72 with EBIT(1 - t) + dep - WC&FC Inv = 72 + 10 - 10 = 72 EBITDA(1-t) + dep(t) -WC&FCInv = 80 + 2 - 10 = 72 NI + dep + IntExp(1-t) - WC&FCInv = 64 + 10 + 8 - 10 = 72 Where does the other 2 go?! My brain can’t be this fried.

To get FCFF from EBITDA use EBITDA(1-t)+ (Dep*t)-FC-WC Which gives: 100(.8)+2-10 = 72 The tax you used is after Dep and Int have been considered, you can’t just plug that back in. T/G

Let me see if I am getting this straight, in FCFF, we do not consider the tax shield of interest? We calculate taxes based upon EBIT? If this is true, then FCFF as defined as “CF to company’s suppliers after operating expenses (included taxes)” and WC&FCInv seem incorrect to me. This doesn’t make sense to me.

I think it has to do with me including both the tax shield from the NCC and adding back the NCC. But after paying my COGS and SG&A, I have 100 left and then have to pay 16 in taxes and put 10 back into WC&FCInv, isn’t the FCFF = 74?

ChadD Wrote: ------------------------------------------------------- > Let me see if I am getting this straight, in FCFF, > we do not consider the tax shield of interest? You add back after-tax interest when you start from *Net Income.* I think you’re mixing up all the different FCFF formulas. What you add or take out depends on where you start - NI, EBIT, EBITDA. It might help if you took a look at a generic income statement.

Thanks for reply. I understand the formulas. What doesn’t make sense is how I can have \$100 in operating margin, then put \$10 in WC&FCInv and pay taxes of \$16 and how that equals \$72.

It’s because FCFF is discounted at after-tax WACC.

FCFF = NI + NCC + INT*(1 - T) - FC - WC ----FCFF = 64 + 8 + 10 - 10 = 72 FCFF = CFO + INT*(1 - T) - FC —Not Enough Data FCFF = EBIT*(1 - T) + D - FC - WC —FCFF = 90*0.80 + 10 - 10 = 72 FCFF = EBITDA*(1 - T) + D*T - FC - WC —FCFF = 100*0.80 + 10*0.20 - 10 = 72 I don’t see any inconsistency here = ANS = 72

I wasn’t contesting the accuracy of the formulas. What doesn’t match is calling FCFF the cash flow available to the firm after paying operating expenses, taxes and WC and FC investment. In my hypothetical situation above, the FCFF is \$74 and should be discounted at before-tax WACC. The various methods of calculating FCFF are done so with the purpose of using DCF analysis to value a firm by using after-tax WACC. I don’t believe Schweser makes any mention of this and I read the CFAI text this morning and there are two paragraphs about it. Basically, the actual FCFF is \$74 but because we use after-tax WACC, we need to use after-tax interest expenses (reducing the tax shield of interest expense by \$2) and for the purposes of valuing a firm FCFF is \$72.

The \$2 difference is the depreciation tax savings that is not included when you start with EBITDA. Start with EBIT & you’ll get it right

I disagree. The \$2 difference is attributed to not including the tax savings of interest expense. Net Operating Profit minus taxes minus change in WCInv minus FCInv (I’m talking strictly just the CFs here e.g. after I payed COGS and SG&A, I had \$100 left, then I had to pay the tax man \$16 and put another \$10 in reinvestment so I should have \$74 left) does not equal FCFF for purposes of DCF valuation. Since we use after-tax WACC, we need to remove the tax savings of interest expense.

Can’t use use after tax WACC and income after tax savings from interest expense. You’re counting the tax savings twice.