When to use NCC and Dep when deriving FCFF and FCFE

CFA Level II Equities
#1

When FCFF is first derived from Net Income, the book adds back NCC. Same thing for FCFE.

However, all other derivations of FCFF and FCFF use Dep in place of NCC. Why is that? Is that an assumption that needs to be made to make everything balance?

#2

Depreciation and Amortization are NCC (Non-Cash Charges).

#3

I know that. Why doesn’t the book continue using NCC? Why does it switch over to Dep in the other equations?

#4

Think about cash for a moment and ignore the formulas. Regardless of what your formula is, you should be adding back all non-cash charges. I’ve always had a problem w/ the standard FCFF formula just saying depreciation cause it’s just the most common example of a non-cash charge.

#5

That makes perfect sense. I don’t know why the book switches over to Dep out of the blue. They should stick with NCC and in most easy problems, depreciation will be the only NCC.

#6

If I recall correctly all the formula’s that switch NCC to just depreciation is because they use EBIT or EBITDA instead of NI. Since the only real non cash charges are coming from those two should be Depreciation, they only need to be adjusted by that.

#7

I think it’s just the standard to call free cash flow ebit*(1-t)+dep-FCinv-WCinv.

However, as mentioned previously this isn’t exactly true in all cases. A good valuation textbook should break this out, and IRCC, I believe schweser leaves a note when covering this to mention what I previously said. All non-cash expenses should be added back, but depreciation is just most common so it’s used in the formula. Also the main reason is that since this variation of our FCFF formula starts w/ EBIT, depreciation is likely to only be the non-cash charge that affects EBIT (not always true, however), while on the other hand if we start w/ NI, it’s more likely that there will be other non-cash charges that fall below EBIT, but are accounted for in Net Income (gains/losses are just one example.

#8

NCC is also increase in deferred tax liability and gain/loss from sale of asset

#9

NCC is also change in long term provisions but such case I have never found in CFAI material.

Any NCC may be counted.