Assigned Reading #41: Free Cash Flow Valuation net, available, something, interest

Wasteoftime

Two questions:
In calculating free cash flow from net income,
FCFF= NI + NCC + [Int x (1-tax rate)] - FCInv - WCInv
why do we not tax affect the NCC as well? After all, depreciation and amortization are tax-deductible, just as interest expense is. Am I missing something?
Why is net borrowing added back to FCFF to get to FCFE? In what sense is cash that was just issued through a debt issue available to equityholders but not debtholders?
Thank you.

thecfawannabe

#1 Question:
Dep and Amortization are NonCash and so are not actually paid out,
Whereas Int Expense is an actual cash payout.
So, it only costs the firm Int(1-taxes) to pay out the actual Int amount b/c of the tax effect. (ie firm owes bondholders $100,000 and is is 30% tax bracket it only costs the firm $70,000 b/c of a $30,000 tax deduction). On the otherhand NCC is noncash so the company doesn’t actually pay anything out and therefore it needs to be fully recognized back in for free cash flow (the only actual cash flow is the reduction in taxes which is included in NI).
#2 Question:
the borrowing for FCFF is cancelled out because even though the company took in $x it also owes the bondholders $x
If you are looking at FCFE you have paid off the current amount of debt owed, so this reduces the amount you have available to Equityholders (since they are only paid after bondholders) and you still have the amount borrowed, but now you don’t owe that amount to the equity holders, so you add that amount back in (Borrowings - Interest expense = Net Borrowing).

towardsutopia21

I think I didn’t state my question clearly.
When add back interest to Net Income to get to FCFF, we tax affect it, because theoretically, if you didn’t pay the interest expense, then you wouldn’t have the benefit of the tax deductibility of that interest expense.
Why does the same logic not apply to D&A? i.e. if you didn’t pay the D&A, then you wouldn’t have the benefit of the tax deductibility of that D&A? Is the answer that we are adding back the D&A due to its being a noncash expense, whereas we are adding back interest expense for a different reason, i.e. to determine what cash flows are available to the firm?

Wendy01

Depreciation and amortization is a non-cash item so we must add the full amount back. We only add back the after tax cost of interest since the government is subsidizing part of the interest cost.