EBITDA 220.00 Depreciation (49.50) EBIT 170.50 Interest (17.25) EBT 153.25 Tax...

EBITDA	220.00
Depreciation	(49.50)
EBIT	170.50
Interest	(17.25)
EBT	153.25
Tax (30%)	(45.98)
Net Income	107.28

Assuming that the tax rate is 30%, Working Capital and Fixed Capital investments are Zero, Calculating FCFF from Net Income shows the following:

FCFF = Net Income + Interest Expense (1-T) + Depreciation Expense

FCFF = 107.28 + 17.25 (1-0.3) + 49.50

FCFF = $ 168.85

Required: Why do you add back the after-tax interest but the before-tax depreciation in the calculation of FCFF?

Expert Solution

Free cash flow is defined as the cash flows that a firm has left to pay stockholders and debt after meeting its operating and investment expenses.

Net Income includes tax savings from debt and operating expenses. Depreciation is a non cash expense and hence has to be added. It is added back at before- tax depreciation since depreciation is an allowable expenses for companies to deduct as per IRS rules. However , after tax interest is added since there is a cash outflow of interest and the company is only saving on the tax on interest.

As per the above question , depreciation is $49.5 and tax benefit on it 14.85. The company has no cash flow of $49.5 with regards to depreciation and also is deriving a benefit og $14.85 on it . Hence the whole of depreciation is added back. Whereas in case of interest , the company is actually having a cash outflow of 17.25 and tax saving is $5.175.Hence the post tax interest is added to arrive at FCFF.

jeff jeffy answered 2 years ago

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