What tax and interest figures to use for FCF calculation?

Based on the most helpful WSO content, here's how you should approach the tax and interest figures for Free Cash Flow (FCF) calculation:

1. Tax in FCF Calculation:

   • When calculating Free Cash Flow to the Firm (FCFF), you start with EBIT (Earnings Before Interest and Taxes).
   • You then tax affect EBIT using the marginal tax rate to get the tax-affected EBIT. This is because the marginal tax rate is the rate applied to incremental increases to taxable income, which in the U.S. is typically 21%.
   • The reason for using the tax-affected EBIT is that it represents the residual profit after all operating expenses, adjusted for non-recurring items and estimated taxes.
   • It's important to note that while the effective tax rate can serve as a reference, the marginal tax rate is ultimately what is used in the unlevered free cash flow calculation.

2. Interest in FCF Calculation:

   • For Unlevered Free Cash Flow (FCFF), interest is not subtracted because FCFF represents cash flows available to all investors, both debt and equity, before the payment of interest.
   • However, if you are calculating Levered Free Cash Flow (FCFE), which is the cash flow available to equity holders, you would subtract cash interest.
   • If the company includes interest paid in their cash from operations, and you are calculating FCFF, you would not adjust for interest as it is not a consideration at this stage. For FCFE, you would subtract it since it's a cash outflow relevant to equity holders.

Remember, the treatment of tax and interest in FCF calculations depends on whether you are calculating FCFF or FCFE. For FCFF, use tax-affected EBIT and do not subtract interest. For FCFE, start with net income and adjust for interest accordingly.

Sources: Notes for Technical Interview Questions, EBITDA vs. Operating Cash Flow vs. Free Cash Flow, DCF Modeling Course ~ Pre-training text.pdf, EBITDA vs. Operating Cash Flow vs. Free Cash Flow, POPULAR ACCOUNTING/FINANCE QUESTIONS