WACC question

CFA General
#1

Hi everyone,

Let’s assume the company is 100 % financed by debt . Cost of debt is 10%. Risk free rate and inflation is 0 in the forecast period.

FCFF are as follows:

Year 1 2 3 4 5

EBIT 100 100 100 100 100

Taxation 0 0 0 0 0

NOPLAT 100 100 100 100 100

D&A 0 0 0 0 0

Change in working capital 0 0 0 0 0

Capex 0 0 0 0 0

FCFF is 100 100 100 100 100

So interest on debt is 10 10 10 10 10

So the PV of interest is 50.

I unerstand that discounting should result in 450 (100*5 during the forecast period - 50 of interest paid across the years).

Shouldn’t FCFF be 100/1,1= 90,9 during all the period (because interest rates=0%)?

Bottom line: The results of dicounting FCFF should be the same as subracting interests from fcff every year and dicounting. Am I right or wrong ?

#2

This is kinda all over the place, first off to answer your question unless interest is zero than no FCFF and FCFF less interest will not be equal.

To do a DCF you would project out your free cash flows and then discount them at your cost of capital, if you have a cost of debt of 10%, you discount at 10%, even if the risk free rate is 0%. You would not apply the cost of debt to your cash flow as a percent.

Also just a note the tax you apply to EBIT to reach NOPAT does not depend on the capital structure, so you would still apply the tax rate, and then also apply it to the cost of debt.