FCFF - Equity vs Corporate Finance

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Ernest Seow

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Dear all,
I understand from Equity section that free cash flow to firm (FCFF) is defined as the available cash flows after the necessary investments (FCInv and WCInv) has been made. Assuming U.S. GAAP: In the event if the company receive interest income from, maybe their investment in debt securities, am I right to say that we do not need to do anything to this interest income? My explanation: This is this is one of the sources of income which is available to the capital providers of the firm and at such there is no need to adjust out the interest income.
The above brings me to my next question. Under topic on M&A in Corporate Finance, there is this pro-forma calculation of free cash flow which is:-
Net Income
- After tax net interest expense
Unlevered Net Income
, where net interest expense = interest expense minus interest income
Question 2: Why in this case is interest income being accounted for?
Thank you.
Cheers,
Ernest
 
we are told WCInv is not “current assets - current liabilities”, its “accounts receivable - accounts payable”.
On the interest expense, I would deduct any interest received here, or add debt securities bought.
One is a plus, the other is a minus so a nice way to catch people out with the adjustment.
question 2. same answer as above.
(disclaimer - I scored <=50% on both EQ & CF last year)
 
for calculation of FCFF, I start from After tax operating income as its before the debt payments and subtract the change in WC and Capex to get the FCFF
In the curriculum, it puts in a different way, it asks you to add Net interest after tax to the net income that gives you Unlevered Net income.
You know that operating income - Interest expenses/Income wil give you the Net Income, So the unlevered net income is the same as After tax operating income as you add back the after tax Net Interest to the Net income.
Hope that answers both of your questions
 
Thanks guys.
Im puzzled as to why interest income is adjusted out when computing FCF under corporate finance section. It makes more sense not to adjust it out as they are one of the sources of income available to the firm.
 
Its simple accounting.
To get Net income, you need to subtract Net Interest and that Net interest is Interest expense - Interest earned
In exceptional cases if your Interest earned is part of Operation, then you include that in Operating income ( EBIT) else its used together with Interest expense to get Net income
Hope that clarifies
 
saurabhm wrote:
Its simple accounting.
To get Net income, you need to subtract Net Interest and that Net interest is Interest expense - Interest earned
In exceptional cases if your Interest earned is part of Operation, then you include that in Operating income ( EBIT) else its used together with Interest expense to get Net income
Hope that clarifies
Click to expand...
thanks saurabhm. I understand the accounting portion of it. I just don’t seems to be able to justify why interest inckme
need to be adjusted as they are sources of income available to the firm. Thanks anyway :)
 
Anyone?
Rephrase my question this way:
Why FCF under topic- Corp Finance we use after tax net interest expense but under topic - equity we only use after tax interest expense
 
Perhaps in Corporate Finance the author realized that a company coule have interest income that isn’t part of its continuing operations and decided that it was best to remove it (because it isn’t as permanent as operating cash flows), whereas the author of the Equity section didn’t think it through that far.
I, for one, wouldn’t worry about it; you won’t see any interest income in a problem in Equity, so it’s moot.
However, if you really, really must know, I suggest that you contact CFA Institute and ask them; in my experience, they’re quite agreeble about answering such questions.
 
Thank you, Bill.
Thanks to saurabhm and onlysimon too for assisting!
 
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