Capital Leases and how it affects FCFF/FCFE
For academic purposes, I have to do a DCF using both FCFF and FCFE. The company I am valuing relies heavily on leasing properties instead of the traditional capital expenditure to drive revenue growth. Following post IFRS-16, the problem I faced is:
1) My calculated FCFF values are very high, since I will add back both depreciation and interest expense. After deriving my enterprise value, I simply subtract current lease liabilities to arrive at equity value. However, the current lease liabilities on the books is but a small fraction of the future lease liabilities, resulting in a very high equity value
2) On the other hand, my calculated FCFE values are very low, as I now need to subtract the principal payments, which are quite significant in the future since the whole business is driven off that and that it is expected to expand aggressively in the future, resulting in a very low equity value
As a result, the equity values that I arrive at between the two methods are very different. Am I doing something wrong? To clarify, when arriving at FCFE, do I add new lease liabilities addition? I understand it is not a cash inflow, but I am a little confused on this.
I usually think it’s easier to treat the cash lease expenses as opex and deduct from EBITDA (and not adding back the lease related D&A to FCF), run the DCF and only subtracting financial net debt (ie not leasing debt) in the bridge to arrive at EqV.
As you said, the current lease debt does not reflect all the future lease payments you are projecting out and hence would need to recalc that debt, which is quite the nuisance.
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