Equity: Adjusted CFO only, equation, interest, equity

torontoanalyst

From Schweser Equity Book 3, page 245:
Adjusted CFO = CFO + [interest * (1 - t)]

Adding back the interest to CFO in the Adjusted CFO equation above indicates that operating cash flow is going both to equity owners and debt holders, i.e. to the whole firm. If operating cash flow is to be directed only to the equity holders then interest paid to the debt holders should not be added back. Keeping this in mind have a look at the Schweser's P/CFO ratio below:

From Schweser Equity Book 3, page 245:
P/CFO ratio = market value of equity / cash flow
where
cash flow = CF, adjusted CFO, FCFE, or EBITDA

If we were to slightly reword the equation to:
P/CFO ratio = market value of equity / adjusted CFO

then this indicates that for a unit of 'operating cash flow to both equity and debt holders' there is x amount of equity value. Isn't this misleading since the equation either needs to add value of debt in the numerator or not use 'adjusted CFO' in the denominator? If we leave it the way it is the equation will overvalue the 'value of equity'.

Note: this has been briefly discussed before in the middle of another non-related long thread - never reached a consensus though - so I thought I repost it.