Explanation:
The correct formula for FCFF (Free Cash Flow to Firm) is:
FCFF = CFO + Int(1 - Tax Rate) - FCInv
Where:
The error is in the treatment of depreciation. Depreciation is already included in the calculation of CFO, so adding it separately would result in double-counting. When calculating CFO using the indirect method, net income is adjusted for non-cash items like depreciation. Therefore, adding depreciation again would overstate FCFF.
Correct approach: Depreciation should not be added separately because it's already accounted for in the CFO calculation.
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An analyst estimates a company's FCFF by summing cash flow from operations, depreciation, after-tax interest expense, and then subtracting the investment in fixed capital. An error is made in the computation regarding the treatment of:
A
depreciation.
B
interest expense.
C
investment in fixed capital.
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