On Book 3 of Schweser, P 204, they comment that EBITDA will be an adequate measure if capital expenses equal depreciation expenses.
Can someone clarify?
If you recall the FCFF formula, you have:
FCFF = NI + NCC + Interest Expense*(1 - tax rate) - Fixed Capital Investments - WC Investments
where NCC are the Non-cash charges, this includes depreciation being this the most relevant amount, so assume NCC = depreciation.
The book is telling that Depreciation = FC investments + WC investments, so the net each other. Then the FCFF formula ends to be:
FCFF = NI + Interest expense*(1 - t) >> this is close to EBITDA amount
why would there be any depreciation in WC Investments?
I believe it should be FC Investments ONLY… Because only that is depreciated.
Adequate measure of . . . what, exactly?
FCFF?
Yes, FCFF.
In my view, even if capex = depreciation, so we only have maintenance capex, we would still be ignoring WCinv by using EBITDA, so it is never an adequate measure, unless we have stable WC, correct?
Thats exactly why “EBITDA is a poor proxy for FCFF”.
Yes, EBITDA is 98% of the time a bad proxy for FCFF.
However, some non-capital-intensive industries could use EBITDA as a proxy for FCFF. Service industry firms? A real example could be a spa, pool table establishments, at-the-level parkings (not structures), etc.
Agree, makes sense!