two questions about DCF
Dear All,
I have two questions about DCF. The first is that most of the time when you do a DCF, you start with EBIT(1-tax) and then +depreciation-capex+/- change in working capital to arrive at free cash flow to firm. And the tax is certainly no the tax expense in income statement.
However in the following extract from an analyst report, when doing a DCF analysis, the analyst start with EBIT and then minus the tax expense in the income statement instead of using the EBIT(1-tax) formula, is he correct in doing this(you can look at the number in the tax expense in income statement and that is the same as the tax payment in DCF)?
Second questions is that usually the income from investment in associate is not included in the calculation of free cash flow to firm but investment in associate is treated as non core asset and subtract from the enterprise value. however in the following extract, the analyst include the income from investment in associate in the calculation of free cashflow and do not subtract the investment in associate from the enterprise value, , is he correct in doing this?
the income statement, balance sheet, cashflow statement and DCF is in below, appreciate any comment or help, thank you
On your first question, for historical periods you use the actual tax paid because you are interested in finding the actual free cash flow, hnce you should take actual tax expenses. You are probably confused with future projections, where you use EBIT * (1-tax). That is done because interest is tax deductible.
Then about your second question, I do not see income from associates being added anywhere. Maybe you are mistaking Macau for an investment, Macau is a region in China with some political history, like Hong Kong. The analyst does subtract the income from associates, see "minus minority interests".
hello PocketMonkey,
thank you for your help. my question is if your EBIT is $100, interest is $20 and tax rate is 30%, then the tax expense in income statement is (100-20)30%=24 and if we are using the EBIT(1-tax rate), then the tax expense is 10030%=30, so there is a difference in tax and so i think it is wrong to use the tax expense directly from the income statement in doing a DCF but that’s what the analyst do, he just use the tax expense in the income statement instead of using the EBIT(1-tax rate) and so i wonder is it correct or not?
and about the investment from associate, my previous understanding is that these investment are non core asset and so you dont include the income from these assets but you subtract it from the enterprise value . but you can see in the income statement that there is a line of income from associate, and those number is the same as the income from Macau in the DCF and that means the analyst include the income from associate in calculating the FCFF and so he does not subtract the investment in associate from the enterprise value too, is this legitimate to calculate in this way ?
On the tax issue: you are mistaking effective tax rate and corporate tax rate. In reality tax is not just calculated as profit before tax x tax rate but it is calculated with more complex calculations for which you need tax specialists. As I said, interest is tax deductible, hence the effective tax rate is different to the corporate income tax rate. Therefore, it is best to take the income statement's tax fo historical figures as that displays the actual, effective tax paid. Going forward it is hard to calculate the actual effective tax rate, a good proxy for that is EBIT x (1-rate). EBIT is used instead of EBT to proxy for the deductibility of interest expenses.
On the Macau issue, excuse me, I misunderstood and misread. Investments in associates are not necessarily non-core, in accounting terms it means that the mother company holds 20-50% of that investment's equity. Does not necessarily have to be non-core. In my first answer I mistook it for minorities, that is something different as that indicates the minority interests that other parties have in the mother company.
Pocket Monkeys answer is way too confusing and does not answer the question of him at all. So let me get this straight. The correctness of the calculation as shown (take the tax amount from the Income Statement so interst is deducted and tax shield applied) depends on whether the Discount Factor (the WACC) includes the tax shield or not. If it includes the tax shield already it is clearly wrong and you are totally correct to be suspicious.
EDIT: I can see that they apparently don't have any interest income or expenses so EBT is equal to EBIT therefore it does not make a difference whether you take the real tax or the "DCF Tax"
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