FCFF Question

[StrategyGuy]

I suspect some in this forum today will derive value from my post. At least, that’s my goal.

[s_s]

@S2000magician

If we hadn’t paid the interest to the bondholders, we would have had to pay $3 million (= 30% × $10 million) in taxes. Because we paid the interest, we have to pay only $2.4 million (= 30% × ($10 million – $2 million)) in taxes. The difference is $0.6 million. You can think of it this way: we paid $3 million in taxes, then the government paid us $0.6 million, for a net of $2.4 million in taxes.

Either way you look at it, we have a cash (out)flow (for taxes) that is lower by $0.6 million because we paid interest to our bondholders. We paid them $2 million, and saved $0.6 million, so net, we’re out only $1.4 million (= (1 – 30%) $2 million); that’s our net cash (out)flow.

Note to self: EBIT first, then EBT, then net profit. Interest goes first, that’s why there is a “tax shield”