Basic interview question (FCF)

Hi,

I'm sorry in advance for how basic this is. I'm a sophomore and got super lucky with an interview at a BB before studying abroad next semester. I haven't had the finance classes yet so I just got the WSO guides and am going through them. I read the Vault guide thanks to a school account and just had the first round interview via Skype.

I did great on the behaviorals and got the next round but flubbed a few of the technicals though, so my contact said I should study up before the superday next week. Please help me, this would be a dream come true.

One was about EBITDA and FCF. I was given these numbers:
EBITDA - $500m
D&A - $50m
Capex - $50m
Working Cap. - $30
Tax rate - 10%

I am looking at page 19 in the WSO guide that shows how to get from EBIT to FCF, but how do I get from EBITDA to FCF? I think I messed something up on Skype. Do I take EBITDA, subtract D&A to get EBIT, multiply EBIT times (1-T), add D&A back, subtract working capital change, and subtract Capex? That would look like this:

$500 - $50 = $450
$450 * (.9) = $405
$405 + $50 = $455
$455 - $30 = $425
$425 - $50 = $375

 
Excuse Me Please:

It is not a stupid question. I have an elementary understanding. If you know, can you please walk me through how this would work for FCFE? From Google searching on this topic I see different calculations for FCF to Firm and FCF to Equity.

fcff - after-tax interest exp + after-tax interest income - debt repayments + debt issuances
 

^this. After awhile you will be able to calculate FCFF/FCFE intuitively I promise, and hopefully the below will explain the logic.

Remember that free cash flow to the firm (your first calculation) calculates cash generation available to all investors/forms of capital I.e. debt and equity after essential expenses (hence you adjust for changes in working capital and capex requirements)

free cash flow to equity (levered free cash flow) calculates how much cash is available to equity holders only, after a) debt holders have been satisfied (in that year) and b) any transactions in the debt markets (I.e. if you borrow an extra £10m then you have an extra £10m million of free cash that period). Hence the equation above that kidflash provided would be used to get from FCFF to FCFE.

Hope that helps.

 

Thank you so much.

Okay, so would an interviewer give me the after-tax interest expense and interest income numbers, or would I be expected to calculate them on the fly? I guess what I am saying is would someone give me the number I need and only require me to know the formula, or would someone go:

Interest expense is $10 and the tax rate is 10%

and expect me to know what to do?

 

sometiems they won't even give you this; you'll have to ask.

for example, once during an interview, i had calculated FCFF, and my interviewer said ok, so now calculate FCFE and shut up.

so i had to ask, ok. so now i need to take into account the capital structure effects, what kind of interest exp/income did they have, did they issue debt, payback debt, etc.

 

I'm certainly not an expert but I'll throw my 2 cents.

I don't know why you would add a debt issuance. Financing activities don't affect the cash flow generated from operations which is really what we care about here.

Also note that it isn't just +/- WC changes, we want to look at anything related to the companies core business. I think you would actually account for an impairment or another non-cash charge like that if you were looking historically. But if you were projecting cash flows you would set this as zero because you don't reasonably assume that things like impairments happen on a recurring basis.

 

It actually does. The formula you are looking at is a very simplified version of FCFF (and its not complete): - You did not add back other Non-cash charges(ie. Stock Based Comp, etc) - You have to add back Pref. Div if present - When you say EBIT, essentially, it is being used as a prediction of the company's pre-tax operating earnings. Getting into more details, you really want to find the underlying operating earnings. This accounts for aspects such as goodwill impairments, changes in Accounting assumptions, gain/loss on asset sales, provisions for future losses, etc.

Lastly you would not account for debt issuance for FCFF, as FCFF is not effected by a company's capital structure. Now if you were referring to FCFE, then yes you would account for debt issuance and repayment which would be encompassed in 'Net Borrowings' which are added to arrive at FCFE.

I hope this helps. Let me know if you have any other questions.

 

the FCF formula you wrote is for un-levered FCF so it's cash that's available to both the Debt and equity investors. Once you factor in the effects of debt you are looking at levered FCF which would be cash only available to equity investors. Hope this helps

 

I think you answered your own question. FCF measures the cash flow available to equity and debt holders, and taxes are not since they are paid away. Also, there are not many ways of deriving FCF. You can start from revenue, net income, EBITDA, EBIT, or any other line, but at the end of the day, there's only one way of deriving it.

 

A little bit more as I am reading still..... When I begin my DCF I start with operating profit (which means pre tax). Therefore I do not need to make and cash adjustments for tax payments and this means that my FCFF will not include tax cash flows whereas my CF statement DOES include tax cash flows

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