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The question is:
Assuming a FCFF figure for year 1 is £1m, for the items below calculate how a £200k increase in each item below would impact on FCFF. Assume where relevant a tax rate of 20%.
1. Depreciation (assuming it is tax deductible)
2. Accounts receivables
3. Interest expenseAnswer:
1. +40k
2. -200k
3. no impactI understand #2 and #3 but i couldn’t figure how the logic for #1.
I thought the formula for FCFF is NI + NCC(noncash charges e.g. depreciation) – WCInv + Int * (1-tax) – FCInv
So why was the increase only 40k and not 200k ?
Even if it’s ‘tax deductible’ shouldn’t it be +160k?
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Isn’t FCFF actual cash flow? So any depreciation adjustments wouldn’t actually directly impact FCFF, but the tax savings it generates (assuming an increase in £200k in depreciation saves you 200*20%=40k) will be added to the FCFF.
In terms of explaining it via the formula, your NCC would increase by £200k, but NI would decrease by £200k as well, plus an increase of 40k in tax benefits. The better formula to use would be:
EBIT * (1-tax) + Depreciation & Amortization – WCInv – FCInv
So adding your 200k increase to depreciation, you get
(EBIT – 200k) * (1 – 20%) + (D&A + 200k) – WCInv – FCInv
= EBIT – 160k + (D&A + 200k) – WCInv – FCInv
= EBIT + D&A – WCInv – FCInv + 40k -
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