440 Lecture 2
440 Lecture 2
440 Lecture 2
FCF is basically the return a company (profit seeking) generates for its capital
providers.
Assets Debt
Shareholders (equity)
Bondholders (Debt)
EBIT = 100 – 10 = 9 – 18 = 80
TAX = 20%
OCF is the return that a company generates for all its capital provider after
fulfilling all operational obligations
Return that free of all obligations = OCF – CAPEX – Net Working capital
investments
Obligations:
Operational
Sustainability
o Long-term (Capital investment for growth)
o Short-term (working capital investment for liquidity)
In free cash flow the cash flow we’re talking about is not only cash. This cash
flow means all returns/profit.
Pathao’s CFO: what is your cash flow for 2019 through operations. Profit in
2019 through operations?
I/S
Sales – cogs = GP – salaries – marketing exp - R&D – Depreciation – utility =
EBIT – interest = EBT or taxable income – TAX = Net profit (includes the tax
benefit from interest. But if I get rid of interest then I also have to get rid of the
tax benefit)
Now, the company can freely and without hesitation distribute this profit
amount among all capital providers. This is the take home money. This is the
true profit. And as this profit/return amount is free of all obligations, this
return is known as FREE CASH FLOW (FCFF) or CFFA.
Sales-COGS – OE – interest = taxable income - tax = net profit ; this profit is free of
all operational obligation.
I can call my net profit my operational income. Operational income should come
from all operational items: revenue and expenses should all be operational. As
interest is non-operation, so we have to add back the deducted interest amount to
get the pure net operational earnings amount. Furthermore, as interest reduced our
tax amount, we also call interest tax shield. Now as I’ am adding back interest to
calculate the OCF, we have get rid of the tax benefit received from interest.
free cash flow or Cash flow from firm assets (CFFA) = OCF – CAPEX – Net WC
Inv
(OCF) = Net income + interest (1-T) + Depreciation
o or OCF = EBIT + Depreciation – Tax
CAPEX (this year) = Ending Gross FA – Beginning Gross FA
Net WC Inv. (this year) = Ending WC – Beg WC = Ending (CA – CL) – Beg
(CA – CL)
o WC = CA – CL
Free Cash flow is the return that a firm generates for its capital providers
(shareholders & lenders) after fulfilling all operational, long-term as well as short-
term day-to-day obligation/requirements. In Cash flow, FCF is also known as CFFA.
PV = return/1+r
The return that we generate to calculate value is free cash flow. FCF is more
sustainable for the company compared to net profit.
FCF is the free income for all capital providers. Anyone who provided capital in this
company can look at the FCF amount and say this is basically the return of the
company.
BRAC
Revenue
o Tax, VAT, and return on different investments: bonds, stocks, funds,
real estate, currency, precious metal etc.
Debt Finance
o Treasury bonds, taking loans from global aid agencies, such as World
Bank, JICA etc.
Taxation Policies: taxation falls under fiscal policy. On the other hand, controlling
money supply falls under monetary policy.
Marginal Taxation: progressive tax; tax rate will increase with income.
There are income slabs or brackets that decide how much tax you have to
pay.
Average Taxation: flat tax regardless of income
o 20%
Example of marginal tax: Let’s say Mr. X earned 50,000 USD last FY. He has to pay
tax using the following marginal tax schedule:
0- 5000 0%
a15000 – 9000 10%
b9000 – 20000 12%
c20,000 - 40000 15%
d40,000 - 60000 20%
e60K & above 25%