The FCFF is calculated by this formula FCFF=NI + NonCashCharge+InterestExpenses×(1-tax)-FCInv-WCInv
In schweser Book2,2017, page 112, NonCashCharge is ussually DEPRECIATION. In page 113, FCInv = change in PP&E+ DEPRECIATION. So, DEPRECIATION is eliminated in FCFF and doesnt impact the value of FCFF.
But in Curriculum page 318, question 1C, DEPRECIATION is impacted 40% of FCFF.
So, what is the real formula for FCFF?
Thank you in advance
FCFF = NI + NonCashCharge + InterestExpenses×(1-tax) - FCInv - WCInv
As you wrote.
Depreciation DOES impact the FCFF (and all other Cash Flows calculations) through the tax shield it provides. Remember that depreciation is a tax-deductible expense in the Income Statement. The higher the depreciation expense, the lower the tax paid, thus less cash outflow in the period.
About the FCInv = change in PP&E + Depreciation. This is because most BS statements consider PP&E in a depreciated way (net of accumulated depreciation). Let’s see a simple example:
Suppose a company has 1,000 of PP&E at the beginning of year and its annual depreciation is 100. So, if the company makes no investment that year, the PP&E showed in BS at the end of year would be 900. However, suppose the company made a 400 investment in PP&E, therefore the end-year value showed in BS would be 1,300. FCInv calculation would be Change in PP&E + depreciation, right? 1,300 - 1000 + 100 = 400 (which is cash outflow).
As said above, depreciation does impact cash flows through the tax shield it provides. The curriculum example was about an increase in depreciation in $100, so due the 40% tax rate, the tax expense would be reduced in $40 (note that this is assuming only depreciation changes), so the cash flow would increase in $40.
Regards.
Thank you very much. I think I understand now the problem.
In fact, if my understanding is correct, it seems that there are two distinct Depreciation in the formula off FCFF
The first one is in NonCashCharge. This Depreciation is brut of tax, I call it DepreciationGross
The second is in FCInv. This Depreciation is net of tax, I call it DepreciationNet which is calculated by DepreciationNet = DepreciationGross * (1 - tax)
Hence, the formula of FCFF is
FCFF = NI + NonCashCharge + InterestExpenses*(1-tax) - FCInv - WCInv
with NonCashCharge = DepreciationGross and FCInv = change in PP&E+DepreciationGross * (1 - tax)
or
with NonCashCharge = DepreciationGross * taxand FCInv = change in PP&E (without Depreciation)
If we use the formula FCInv = change in PP&E+Depreciation, the Depreciation in FCInv must be the DepreciationNet and the Depreciation in NonCashCharge is DepreciationGross.
Otherwise, If we use the formula FCInv = change in PP&E ( without Depreciation , in some practice question in Curriculum), we must use (DepreciationGross * tax) for NonCashCharge.
FCInv does not consider DepreciationNet because NI already includes the tax being adjusted for the amount of depreciation in the period (because NI is the bottom line of IS, which is affected by depreciation and amortization, thus the tax payable).
There’s only one Depreciation.
Net vs Gross classification is for PPE and other assets, based on whether depreciation is deducted or not.