Why use NOPLAT? Sample Exam V1

CFA Level II Corporate Finance
#1

The question asks you to find the “estimated free cash flow” for the company. In one of the exhibits they make a point to say that FCF is similar to free cash flow to the firm. So I went ahead and calculated using FCFF as we know it:

FCFF= NI + NCC + Int(1-T) - FCInv - WCInv

I got a wildly different answer than suggested by the answer key. Instead they start from NOPLAT and then make the appropriate adjustments for NCC, FCInv, and WCInv.

Why use this method? And why don’t we arrive at the same answers?

#2

Notice how they didn’t specify it was FCFF. They just said FCF. This is how they measure FCF in the Corporate Finance chapter (under discounted cash flow analysis). The formula is Net income + net interest after tax (unlevered NI) + change in deferred tax (an increase increases CF and a decrease in deferred tax decreases CF). This equals NOPLAT. Then the formula for FCF = NOPLAT + NCC - Change in NWC - Capex

#3

Okay, so then the only differences between FCFF and FCF are that FCF will account for the change in deferred tax. By the looks of it, we can even say that:

FCF = FCFF + change in deferred tax

Is that right?

To be honest I glossed over this section figuring the two concepts were identical…

#4

Just realized the answer to the question in my previous post was no… (I tried to redo the problem using “my formula” unsuccessfully)

Another difference between the two occurs because Capex and FCInv are not the same.

When calculating Capex you add back the depreciation to account for the reduction due to depreciation expense. This makes logical sense, any reduction in PPE due to depreciation should be adjusted for before finding the CF resulting from the change. BUT, this doesn’t happen for FCInv… any idea why?

#5

How’d you guys do in this sample exam?

#6

Another forum member helped me out with this type of problem. The interest expense is not included as you are projecting project cash flows. the interest expense is captured in the WACC used the discount the cash flows.

#7

Not too well, around 60%.

kikentai-- this actually does incorporate the after tax interest by adding it back in order to arrive at the FCF

#8

Yes, it should be kept in. What I meant is that it is not removed as an operating cash flow out.

EBIT - taxes + depreciation - WCInv - FCInv = FCF

#9

Pretty sure this is not correct. FCFF and FCF both account for deferred taxes.

#10

if they give full IS or NI then FCF = EBIT (1-tax) + Depr for the Corporate Finance part

if they give NOPLAT then it’s FCF = NOPLAT + NCC - Change in NWC - Capex as shown above

#11

I got 77%. Doing the second one tomorrow

#12

Conceptually I agree with you. Cash saved as a result of deferring taxes is available to firm stakeholders. However cfa formulas never account for this in fcff.