FCFF from EBIT and EBITDA understand, different, learning, specific, contain

grharmeyer

I'm on my way to learning the eight different FCFF and FCFE formulas and for the time being I am not comfortable with the formulas that begin with EBIT and EBITDA. I searched the forum but did not find an answer. Below are my specific questions:

FCFF = [EBIT x (1-tax rate)] + Dep - FCInv - WCInv

I totally understand that you have to tax EBIT so that the cash flow to the firm must contain EBIT x (1-tax rate). Also, I see that you subtract FCInv and WCInv. The part that is not sitting well is that you add back all of the depreciation. Either way the FCFF figure is after tax so the depreciation should be after tax as well. Any pointers?

luda002

yeah i get you, I'm just suggesting an easier alternative to the grand scheme of things

b_sea93

Thank you for the explanation. I realize that Depreciation occurs above EBIT and I understand that it must be added back. The issue here is with the order of that operation. The two options below do not result in the same figure and it seems to me that taking operating cash, taxing it and THEN adding DEP is wrong. Yes, you should add DEP, but in my understanding it should be done before you tax, otherwise, you are adding a credit that will not be taxed.

[EBIT x (1-tax rate)] + DEP
(EBIT + DEP) x (1-tax rate)

Put another way, kyrylo's example illustrates my point. In the worked out example above, you add back 'DEP * tax' not the full 'DEP' and that is my question.

I must be missing something else. Care to give me some more suggestions? Thanks a lot.

genuinecfa

When you multiply EBIT by (1-T) you are removing all taxes and providing an after tax figure; FCFF is an after tax figure.

If you do the math it works out. Assuming that Dep is the only NCC you have with no Amortization:

Then: EBIT= EBITDA - D

(EBITDA - D)(1-T) + D is the first part of the equation excluding the FC and WC inv.

(EBITDA - D)(1-T) + D = EBITDA - T(EBITDA) - D + DT + D

The D's (depreciation) cancel out and you are left with after tax EBITDA plus after tax depreciation:

EBITDA(1-T) + DT

So IF: EBITDDA(1-T) + DepT = EBIT(1-T) + Dep

Then:

[EBIT x (1-tax rate)] + DEP - FCInv - WCInv holds true



Edited 3 time(s). Last edit at Tuesday, April 19, 2011 at 08:04AM by verse214.

random_walker47

EBITDA just complicates things. Get to EBIT*(1-T) and then go from there

smuggycfa

verse is right in his explanation.

It might be helpful if you do the math:
FCFF = [EBIT x (1-tax rate)] + DEP - FCInv - WCInv =
= [(OPERATING CASH - DEP) (1-tax rate)] + DEP - FCInv - WCInv =
= OPERATING CASH(1-tax rate) - DEP + DEP * tax + DEP - FCInv - WCInv.

After you eliminate the DEP, you are left with the OPERATING CASH after tax + cash tax that was saved due to depreciation.



Edited 1 time(s). Last edit at Tuesday, April 19, 2011 at 06:44AM by kyrylo.