7.7 EBIT Form of FCFF
Free Cash Flows can be computed in a variety of equivalent ways.
One way is directly from the Non US GAAP number Earnings
Before Interest and Taxes (EBIT).
For this method the following notation is again used:
FCFF = Free Cash Flow to the Firm
NI = Net Income after Tax
EBIT = Earnings Before Interest and
Taxes
CFO = Cash Flows from Operating
Activities
DA = Depreciation and Amortizations
ONCI = Other Non-Cash Items
ΔWC = Change in Working Capital
(itemized in the Cash Flow Statement)
This is simple because of the
relationship between EBIT and Net Income:
NI = (EBIT – Interest Expense)*(1 – Tax
Rate)
tc =
Effective Tax Rate
CAPEX = Capital Expenditure
Calculating
FCFF from EBIT
EBIT is related to cash flows from operations (CFO), as measured
under US GAAP, as follows:
CFO = NI + DA + ONCI – ΔWC = (EBIT –
Interest)*(1 – Tax Rate) + DA + ONCI - ΔWC
Substituting into FCFF and cancelling out the Interest*(1 – Tax
Rate) terms we get:
FCFF = CFO + Interest*(1-tc) – CAPEX
FCFF = (EBIT – Interest)*(1 – Tax Rate)
+ Interest*(1-tc) +
DA + ONCI + - ΔWC – CAPEX
CAPEX can be computed directly from the Investing Activities
section of the Cash Flow Statement or it can be computed indirectly
by reconciling the change in real assets for the period in terms of
Depreciation expense and CAPEX such that, CAPEX equals change in
real assets plus Depreciation.