Valuation doubts
Hey guys,
I looked around a lot for answers, but I'm still struggling to understand the answer to two important valuation related topics that I'm currently going through for my interview preparation. So, thought of posting it here.
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Calculation of FCFF - the two accepted formulas seem to use EBIT * (1-t) OR Net Income + Int Exp * (1-t), which lead to the same answer. Regarding the first formula, why don't we remove int exp and tax operating income and then add back interest, to account for the tax deductability of interest? Isn't this result the actual cash flow that's left to be paid to all investors? The common answer seems to be: Tax deductability of debt is adjusted for in WACC. If that's the reason, then why do we adjust the interest expense for Tax in the second formula and discount it by the tax-adjusted WACC? That would lead to double-counting of the tax benefit of debt. Also, if we do not consider the tax benefit of debt in the second formula, then the two formulas provide different FCFF values for the same firm. Doesn't make sense to me at all. Also, is it possible to adjust the CFs for taxes and use a non-tax-adjusted WACC? Would that provide the same answer? If no, why would the firm valuation, given the same historial values and projected assumptions lead to different results?
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Net debt v/s Debt in WACC Calculation - I always thought it was total debt used in the weight of debt/(debt+equity) in the WACC formula, but I suddenly discovered two credible sources - Damodaran and Benninga that use Net debt instead. Damodaran says you can use both provided you are consistent. Does it mean Net debt used with net interest expense (net of cash interest income in the FCFF formula) and Gross Debt should be used Interest expense? If yes, would they produce the same result? Also, if I use net debt, am I supposed to use net interest rate?
I'm a lost monkey at this hour and I would appreciate some help.
