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ACCA Strategic Professional · Advanced Financial Management · Valuation and the use of free cash flows

When forecasting free cash flow to the firm for a valuation, which treatment of items is correct?

FCFF adds back non-cash depreciation and deducts both capital expenditure and increases in working capital. Interest and new borrowing are financing flows captured in the WACC discount rate, so including them would double count, and maintenance capex remains a genuine cash outflow.

  1. ADeduct interest paid on debt in arriving at FCFF, as it is a cash outflow
  2. BAdd back depreciation but deduct capital expenditure and the increase in working capitalCorrect
  3. CIgnore capital expenditure that merely maintains existing capacity
  4. DInclude financing cash flows from new borrowing as part of FCFF

Explanation

FCFF is operating cash flow after tax, plus depreciation, less capital investment and working capital increases. Interest and borrowing are financing flows already reflected in WACC, so including them double counts. Maintenance capex is still a real cash outflow.

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