Hi guys,
To calculate FCF for cash flow projections, the formula states FCF = EBIT(1-T)....... (and so on).
My question is - is it possible to use EBIT(1-T) and (EBIT - Taxes) interchangeably? For (EBIT - Taxes), the amount of taxes can simply be obtained from the income statement/cash flow statement.
Appreciate your help!
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In calculating unlevered free cash flow, you can't substitute EBIT(1-T) and (EBIT - Tax Provision). The provision for taxes on the income statement between EBIT and Net Income takes into account the interest payments the company is making - since interest is deducted as an expense, it reduces taxable income and hence taxes. So if you use EBIT - Taxes in calculating unlevered free cash flows, you will be getting an incorrect result because your cash flows will include the effects of leverage. Then if you use WACC to discount these cash flows, you would be double counting the tax shield benefits of leverage.
So you'll have to subtract taxes on EBIT (i.e., EBIT(1-T), where T is the effective tax rate) and take into account changes in deferred taxes and income taxes payable when calculating FCF, because what you really care about is the amount of cash the company is paying in taxes, not the provision on the income statement. The provision for taxes on the income statement tells you how much tax a company should *eventually pay related to that years operations, but there will almost always be timing differences.
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