Free Cash Flow

[trinianalyst]

Free Cash Flows
The CFA exams have Free Cash Flow To the Firm (FCFF) defined as:
FCFF =EBITBA X (1- TAX RATE) +(DEP X tax rate) –FIXED CAPITAL INVESTMENT- WORKING CAPITAL INVESTMENT
FCFF = NI +Depreciation - WC Inv – Fc Inv +(Interest x Tax rate)
Can you please explain to me why the full depreciation is added back and not the net depreciation.
Ie if the depreciation charge is $100 there is a tax shield of $20 (assuming tax rate if 20%) that will be realized as a tax savings in the cash flow.
For the interest we are adding back the tax shield and treating it as a chas inflow.
Why not the same treatment for depreciation?

 

[AndrewUNH]

hmmm you are adding back the depreciation tax shield b/c its a noncash charge/expense. You don’t add back the full depreciation because it is not all cash flow, just the part you save from taxes AKA the depreciation tax shield. let me know if that helps or not.

 

[Wiedermag]

The Depreciation Tax Shield (DEP(Tax Rate)) is already included in NI.

 

[ov25]

We need to go from NI to a state where Depr effect is eliminated however the tax advantage (real cash flow) is still accounted for.
So NI + Depr(1-tr) [Eliminated Depreciation effect]
NI + Depr - Depr*tr [ Restated ]]
+ Dept*tr [Add real cash savings from tax shield ]
————————————–
NI + Depr
————————————–
Coming to the interest part, here the Firm must pay interest to the Debt holders so it is not available to the firm per se…only portion the firm is entitled to is the tax savings from it = int*tr
Int (tr) [Add Tax saving recvd from paying interest to the Debt holders]
————————————–
NI + Dept + Interest(tr) [Cash flow before investing in the firm]
—————————————-
FCInvestment + WCInvestment [Invesment in the firm]
=======================================
NI + DEPR + INT*TR - FCINVST - WCINVEST = FCFF
========================================

 

[Wiedermag]

Look on relations NI = EBITDA(1-Tax rate) -Dep(1-Tax rate) - Int(1-Tax rate). Two obvious elements of NI are minus Depreciation plus Tax shield [Depreciation(Tax rate)], so adding back Depreciation zero Depreciation leaving Tax shield untouched as a part of NI.