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CA Final · Advanced Financial Management · Business Valuation

Which of the following correctly defines Free Cash Flow to Firm (FCFF) for a company with no preference shares?

FCFF equals EBIT(1 - t) plus depreciation, less capital expenditure and less the increase in working capital. It is the cash flow available to all capital providers before financing payments, so interest and net borrowing are not deducted or added.

  1. APAT + Depreciation - Capital expenditure - Increase in working capital - Dividends
  2. BEBIT(1 - t) + Depreciation - Capital expenditure - Increase in working capitalCorrect
  3. CEBIT(1 - t) + Depreciation - Capital expenditure - Increase in working capital - Interest(1 - t)
  4. DPAT + Depreciation - Capital expenditure + Net borrowing

Explanation

FCFF is the cash flow available to all capital providers before any financing payments. It is EBIT(1 - t) plus non-cash charges less reinvestment in fixed capital and working capital. Option 3 deducts after-tax interest, which converts it towards an equity-type cash flow and is therefore wrong for FCFF.

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