Received this question in one of my interviews.
How does an increase in the tax rate affect the DCF as well as the final enterprise value output?
I would assume that it affects the DCF in two ways:
It would lower FCF because more of the operating income would be paid in taxes.
It decreases the weighted average cost of capital because we multiply percentage of debt within the capital structure by the cost of debt and (1-Tax rate). Thus, increasing the tax rate would decrease the WACC that you use to discount future cash flows.
I'm assuming having a lower WACC would increase the enterprise value? I'm kind fo confused why an increase in the tax rate would increase enterprise value even though it lowers fcf.
Financing cash flows are not included in the FCF calculation, including the tax shield from debt interest payments.
What do you mean by this?
This makes sense to me, unless Im missing something.
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