CFA Practice Question

There are 534 practice questions for this study session.

CFA Practice Question

Watson is planning to value Alcan Inc. for 2016. The financial information Watson has assembled for his valuation is as follows (in millions):

  • EBIT: 500
  • Interest expense: 150
  • Depreciation: 200
  • Income tax rate: 35%
  • Investment in working capital: 80
  • Investment in fixed capital: 400

What is the FCFF for the company?
A. $45 million
B. $220 million
C. -$285 million
Explanation: FCFF = EBIT (1 - Tax rate) + Dep - FCInv - WCInv = 500 x (1 - 0.35) + 200 - 80 - 400 = 45

User Contributed Comments 14

User Comment
truegazzi What about Interest expense?? It must decrease taxes! So FCFF=EBIT - (EBIT-Interest)Tax rate + Dep - FCInv - WCInv = 97.5
volkovv Interest expense is irrelevant here. The reason being that interest is not a cash outflow from FCFF standpoint. When you start calculation from NI you add Interest(1-t). NI already absorbs interest tax shield (interest*t) and FCFF gets both inetrest tax shield and ineterst(1-t). When you start from EBIT since its before interest measure, you simply ignore it.
SDCFA As per LOS "Cash available to shareholders and bondholders after taxes, capital investment, and WC investment".. however this question says EBIT which is Earnings before interest and Tax. Why i dont need to redusce Interest and Depreciation to calculate correct Tax?
xlneo Interest Expense is in the EBIT
bansal Think of it as independent of level of debt because WACC is adjusted for the tax shield on debt.
tim2 It's kind of odd isn't it. I think the equations only make sense if you assume that interest it taxed at the same tax rate as profits. Which I suppose you could but it's often not the case if for example the receiver of the interest is not a tax payer- say a charity that kind of stuff.
Still that's what it says in the cfa equations so I guess that's what they want for the exam.
JCopeland No, interest expense is not in the EBIT. FCFF is cash available to shareholder AND BONDHOLDERS. Bondholders receive the interest. That's why it is not subtracted. Same reason an increase in interest expense does not change FCFF but reduces FCFE by int(1-tax). If you are EBT you have to add interest back in for FCFF
azramirza NI+NCC+INT EXP-FC-WCI=227.5(EAIT)+200+97.5{150(1-0.35)}-400-80=45$
homersimpson On whether to add the tax shield i.e. int expenses*(1-t), since one way to interpret FCFF is what's left for creditors, lets see it this way:

EBIT: interest not paid yet, so naturally no tax shield (no addition)
NI: after paying interest, so tax shield has arisen (addition)
CFO:going to pay interest, tax shield will also arise (addition)
Sam123456 I guess NI + Int(1-t) = EBIT(1-t)?
Sam123456 That's my way of trying to explain that if you are given EBIT and you know the FCFF equation, you know to take EBIT and multiply it by 1-taxrate. Not sure if all that helps but it helps me so I thought I would share it!
jjhigdon 1) Interest expense is not included because it is paid to bond holders. FCFF is cash available to Equity AND bond holders. 2) EBIT is multiplied by 1-Tax rate to account for the interest tax shield (tax avioded via interest tax deduction). 3) Depreciation is added back because it is a non-cash expense that was included in EBIT (EBIT = EBITDA - Depreciation/Amortization).
Inaganti6 INTEREST IS RELEVANT. It's NOT SUBTRACTED FOR THAT VERY REASON !
GBolt93 FCFF=FCO +Interest(1-Tax)-Capex
FCO=(500-150)*.65+200-80=347.5
FCFF=347.5+150(.65)-400=45
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