Hi !
Can someone please explain why do we add Interest (1-Tax) while calculating FCFF with CFO as a starting point, considering the fact that we already add interest expense in CFO.
CFO includes a deduction for interest net of taxes. You’re undoing that deduction.
While calculating CFO, we add the interest paid. So my question is, if we have already added the interest while calculating CFO, why do we again add interest while calculating FCFF, with CFO as a starting point
What makes you think that?
CFF includes interest paid
There appears to be a basic misunderstanding of the difference between free cash flow to equity (FCFE) and free cash flow to the firm (FCFF). FCFE is leveraged cash flow - that means that it includes interest expense. Unleveraged cash flow, also called FCFF, excludes interest expense. That is why that expense, net of income taxes, gets added to FCFE.
From the standpoint of the analyst, FCFF facilitates the comparison in financial performance of firms with different capital structures. For that reason, I find FCFF distinctly superior to FCFE as a comparative metric.
I hope these comments are helpful.