Free cash flow to firm (FCFF) represents the available cash flow for both debt and equity holders of the firm. The cash is remaining cash after paying all its expenses including both operating and capital expenditures (taxes, interest, expenditures etc.).
FCFF is calculated by intrinsic valuation method and terminal value of business.
The formulae to calculate the FCFF are as follows −
Net profit (operating) + expenses (Depreciation and amortization) – capital expenditure – changes in net working capital.
Cash flow (operations) + Interest expenses* (1-T) – capital expenditures
Net income + charges (non-cash) + interest expenses (1-T) – Investments in WC – capital expenditure
EBIT*(1-T) + D&A – Investments (LT) – investments in WC
EBITA*(1-T) + D&A * T – Investments (LT) – Investments in WC
Here, T = Tax rate, WC = working capital, LT = Long term, D&A = Depreciation and amortization, EBIT = Earnings before interest and taxes and EBITDA = Earnings before interest, tax and amortization
Let us consider the following information for understanding purpose−
|Sr.No||Amount in $|
|2||Operating cost (b)||20|
|3||Earnings Before Interest Tax Depreciation and Amortization (a-b = EB)||100|
|5||Earnings Before Interest and Tax (EB-c = F)||90|
|7||Earnings Before Tax (F-I = G)||75|
|9||Earnings after Tax (G-T)||65|
|10||Working capital investment||(15)|
|11||Fixed capital investment (CAPEX)||20|
The solution is as follows−
Interest expense (1-tax rate) = 15 – (1-35%) ⇒ 9.75.
65 + 10 + 9.75 – 15 – 20 = 49.75
90*(1-35%) + 10 – 15-20 ⇒ 33.50