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7.8  EBITDA Form of FCFF

EBITDA is Earnings Before Interest, Taxes, Depreciation and Amortization.  It is a non US GAAP measure that is often used as an approximation for cash flow from operations.   It is popular because it differs from cash flow from operations under US GAAP by excluding interest and changes in working capital.  These differences will become clear in the following reconciliation of EBITDA and FCFF.

Free Cash Flow to the Firm can be derived from EBITDA as follows.  First, we note the differences between EBITDA and Net Income are as follows:

NI = (EBITDA – DA - Interest)*(1 – Tax Rate)

Therefore, EBITDA is related to cash flows from operations (CFO) as follows:

CFO = NI + DA + ONCI – ΔWC = (EBITDA -DA - Interest)*(1 – Tax Rate) + DA + ONCI – ΔWC

ONCI is again Other Non-Cash Items and DA is depreciation and amortization.

Canceling out the common DA terms to get:

CFO = (EBITDA – Interest)*(1 – Tax Rate)+DA*Tax Rate + ONCI  ΔWC

Substituting into FCFF and cancelling out the Interest*(1 – Tax Rate) terms we get:

FCFF = CFO + Interest*(1-tc) – CAPEX = (EBITDA – Interest)*(1 – Tax Rate) + Interest*(1-tc) + DA*Tax Rate + ONCI - ΔWC – CAPEX

FCFF = EBITDA*(1-tc) + DA*Tax Rate + ONCI - ΔWC – CAPEX

The above form allows FCFF to be computed directly from EBITDA.