Equity - FCFF / Capital structure structure, something, interest, because, capital

Walex

Would changing the capital structure of a firm by increasing debt impact FCFF?

I would say yes, because FCFF = NI + Dep + Int(1-t) - FCInv - WCInv
And since we have more debt, interest expense goes up.


Is that correct? Am I missing something?

wizofoz

Theoretically there would be no impact, which is why the curriculum suggests using the FCFF method when the capital structure is unstable.

But, if I were to issue $1000 of debt @ 5%, I would have a $50 annual coupon expense which reduces my NI by $50. But we reclaim the tax benefit of this, which comes out to $25 assuming a 50% tax rate.

NO EXCUSES

19831985

Coshair is Correct answer is no change.

It was in 1 of the mock schweser exams.

I guess that I should have read the question better.
If it meant to raise debt by increasing the Firm Free Cash flow, then correct answer would be an increase in FCFF. But in the question, the raise in debt is only to 'change capital structure'.

Damn

luda002

duplicated..



Edited 1 time(s). Last edit at Thursday, May 27, 2010 at 02:33AM by coshair.

CPATrader

bp, pls note the reduction in NI due to annual coupon expense is also 50*(1-tax rate)

you may refer to the I/S construction of NI. when you calc tax already deduct 50 expense so finally the inpact to NI is only 50*(1-tax), which is added back in Int(1-t), so FCFF remains no change.


\\\

bpdulog Wrote:
-------------------------------------------------------
> Theoretically there would be no impact, which is
> why the curriculum suggests using the FCFF method
> when the capital structure is unstable.
>
> But, if I were to issue $1000 of debt @ 5%, I
> would have a $50 annual coupon expense which
> reduces my NI by $50. But we reclaim the tax
> benefit of this, which comes out to $25 assuming a
> 50% tax rate.

YAhmed

Just as an addition...There was a question about issuing NEW debt when you already have forecasts for FCFF/FCFE in Schweser EOCs.

FCFF does not change at all as it represents cash available to all investors (debt and equity) BEFORE and financing decisions are made.

FCFE increases the year of issue (through net borrowing) and decreases subsequent years, through IE.

ap0258

coshair Wrote:
-------------------------------------------------------
> bp, pls note the reduction in NI due to annual
> coupon expense is also 50*(1-tax rate)
>
> you may refer to the I/S construction of NI. when
> you calc tax already deduct 50 expense so finally
> the inpact to NI is only 50*(1-tax), which is
> added back in Int(1-t), so FCFF remains no
> change.
>
>
> \\\
>
> bpdulog Wrote:
> --------------------------------------------------
> -----
> > Theoretically there would be no impact, which
> is
> > why the curriculum suggests using the FCFF
> method
> > when the capital structure is unstable.
> >
> > But, if I were to issue $1000 of debt @ 5%, I
> > would have a $50 annual coupon expense which
> > reduces my NI by $50. But we reclaim the tax
> > benefit of this, which comes out to $25 assuming
> a
> > 50% tax rate.

Thanks for clarifying.

NO EXCUSES

brainsX

more debt would affect FCFE, but not the FCFF equation, in theory

in practice, borrowing more debt would change your operations and leverage and probably offer more gross margin giving you a higher NI starting point for FCFF.

huangxiaoxie

CPAbeatsCFA Wrote:
-------------------------------------------------------
> in practice, borrowing more debt would change your
> operations and leverage and probably offer more
> gross margin giving you a higher NI starting point
> for FCFF.


More leverage dosn't equate to higher growth in EBIT, perhaps in NI, but that is not what we are looking at with FCFF. (DOL wouldent change)

Are you thinking of a company that retains and reinvests all profits? Which would perhaps be higher? If so, be careful, they could also be lower..

President1988

More debt will not affect FCFF, but will affect FCFE (interest payments up, FCFE down). The main purpose of FCFF is to measure the operating free cash flow that goes to all capital providers, whether debt or equity.

The amount of debt will change the Enterprise Value of the firm, however, since EV = sum of future FCFFs discounted at WACC. Since debt levels will affect WACC, it will affect EV, but not FCFFs.