Equity

CFA Level II Equities
#1

There is this classic question of effects of various PnL and Balance Sheet items on FCFF and FCFE.

1st EOC question in Free Cash flow valuation. I checked the forum, still have a doubt on the effect of increase of a 100$ increase in Depreciation.

When depreciation increases by 100, NI decreases by 100(1-t). So we add back this amount while calculating FCFF. Say tax is 40percent. So increase of 100 in depreciation will increase FCFF by 60?

Is this correct?

#2

Agreed: FCFF will increase by after tax depreciation which is 60. But don’t forget depreciation tax shield of 40 which has also created. Since it is a non cash contra expense so must be added back to NI to arrive at cash flows. Together these equal to depreciation expense.