Interest Income in Models
All,
It's been a while since I've been on these boards, but when building out a DCF, what is the general rule of thumb for the treatment of interest income? I'm building out a DCF on a company who is generating a decent chunk of interest income in the future. However, generally I've built out a DCF with EBITDA as the basis, adjusted for non-cash items and cash taxes to get to NOPAT. If I build out the model starting with the OCF and add back the adjusted interest expense, naturally my DCF comes out to a higher valuation (more so in this case).
Is the add back for adjusted interest expense, when based on OCF, a net number (net of interest income) or should I be adjusting my EBITDA to recognize the interest income.
Thanks for your help.
it is always exlcuded because its value is unfortunately impacted by interest expense which is a factor of leverage... unless interest income is a factor of some capital allocation decision for restricted cash held in marketable securities, then that's fine... just don't apply use it unless there is a pre-specified motive...
this is why you have to be careful with cash taxes, they include the tax deductiblity of interest expenses therefore skewing your unlevered FCF... if you decide to use cahs taxes, make sure you deduct the tax impact of that tax shield in the calculation... also, careful if you're using NOLs in cash taxes, those have to be valued on their own as well...
You decide on a level of interest for the company's cash balance, and you subract it from interest expense to get to net interest expense. Unless the purpose of the company is to earn interest (a bank) or this company has a very large cash balance, don't spend too much time on it.
Some good points above. Sounds like the company has marketable securities and that interest income is part of its normal course of business. I would include interest income but make sure that you do not net it with interest expense as that is already factored in by the cost of capital. I think MezzKet made a great point on cash taxes that is often overlooked.
Just out of curiosity OP, why are you asking this? Are you building financial models for a college course?
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