Answer: depreciation tax shield

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a poor proxy for FCFF (Free Cash Flow to the Firm) because it does not account for the **depreciation tax shield**. The depreciation tax shield refers to the tax savings generated by depreciation expense, which reduces taxable income and thus reduces cash taxes paid. Since FCFF represents the cash flow available to all investors (both equity and debt holders) after accounting for all operating expenses, taxes, and investments in working capital and fixed capital, it properly includes the tax benefits of depreciation. EBITDA, however, adds back depreciation and amortization without considering their tax impact, making it an incomplete measure of true cash flow available to the firm.

Author: LeetQuiz Editorial Team