FCFF -- debt to pay dividend company, interest, increase

meghanjackson

when a company issue debt to pay dividend, what is the effect on FCFF?
Doesn't FCFF increase due to increase in interest?

Newhuman

Anything that is a use (or in other words NOT A SOURCE) of FCFF/FCFE will not affect the FCFF/FCFE.



1) Increase common stock dividends <- use of FCFF / FCFE

2) Repurchasing common shares <- use of FCFF / FCFE

3) Reducing outstanding Long term debt. <- use of FCFF only, NOT FCFE.

liquidity

I don't really understand the need for so much of discussion here and the calculations as well. It's obvious that dividends or debt payments/issuances won't affect FCFF since it's a pre-levered cash flow measure. There's no need to check if it through the formula by adding int(1-t) to the net income. It's simply the fact that FCFF does not account for interest or dividends.


Whereas FCFE, is a post-levered measure and hence accounts for interest and net borrowings(debt payments or issuances). Dividend however, is a payment that can be made from FCFE, so it does not affect FCFE. Only leverage would affect FCFE and the effects would be opposite in the year of issuance and subsequent years. If you issue debt today, FCFE increases because net borrowings increase. Future FCFE decreases because interest payments increase. It would be the other way for debt repayment.

CPATrader

It has no effect.

Just do a simple scenario analysis (simplified to ignore WCInv, FCInv and NCC since they aren't relevant --- and we all know dividends dont impact FCFF or FCFE):

Before issuing debt to pay dividends:

EBIT = 50
Int = 10
EBT = 40
Tax (@20%) = 8
Net Income = $32

FCFF = Net Income + Int (1 - tc) + NWInv + FCInv + NCC
FCFF = 32 + (0.8)*(10) + 0 + 0 + 0
FCFF = $40

Now I issue $100 in debt @ 10% to pay dividends:

EBIT = 50
Int = 20 [10 + (0.1 * 100) = 20]
EBT = 30
Tax (@20%) = 6
Net Income = $24

FCFF = Net Income + Int (1 - tc) + NWInv + FCInv + NCC
FCFF = 24 + (0.8)*(20) + 0 + 0 + 0
FCFF = 24 + 16
FCFF = $40

Voila.

Otabek

But isn't interest and taxes operating cash flow? only principle repayments are financing.
So CFO-interest paid+taxes on interest + (1-t)interest-FCINV
So no impact?

ayodayo

So is the conclusion, no FCFF does not increase from issuing additional debt.

ningning1984

FCFF = CFO + (1-t)interest - FCInv.

kkn006

I'm just reviewing this section now, but if FCFF = CFO - Capex, wouldn't the additional interest paid lower CFO? ... never mind, I think I got it from the above.

Pegasus2008

right i see.. forgot about that.. thanks ramdabom.

bdavi77962

Because NI drops by the same amount as the increase in Int(1-t). INT(1-t) is an addback