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    440 Lecture 2

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    Aditta Saha 2012928630

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    440 Lecture 2

    Uploaded by

    Aditta Saha 2012928630
    8 views8 pages

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    8 views8 pages

    440 Lecture 2

    Uploaded by

    Aditta Saha 2012928630

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
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    Lecture 2; FIN 440

    FCF is basically the return a company (profit seeking) generates for its capital
    providers.

    Assets Debt

    Cash: Return >


    PPE

    Return > Equity


    Return >

    Pay all capital providers:

     Shareholders (equity)
     Bondholders (Debt)

    We use all our assets to generate Sales> Profit/returns

     Sales> Net Profit


    o Why not sales considered as my return?
    o Exclude costs: COGS, operational exp, interest, tax
    o These aforementioned expenditures are obligations that are required
    for me to generate the above stated sales.
    o Al these expenses are known as operational obligations
    o Once I exclude the operational obligations I get my operational return,
    which is known as net profit. We can also call it operational cash flow
    o The cash flow in FCF or OCF is basically your earnings/ returns/profit.
    o OCF is the retun that a company generates from operations for all
    capital providers (shareholders and bondholders)
     Operational cash flow (OCF) = Net profit + interest – interest * tax rate
    o = Net profit + interest (1-T) + Dep

    Sales – cogs = GP – salaries – marketing exp - R&D – Depreciation – utility =


    EBIT – interest 10 = EBT or taxable income – TAX = Net profit 100(includes
    the tax benefit from interest. But if I get rid of interest then I also have to
    get rid of the tax benefit)

    EBIT = 100 – 0 = 100 – 20 = 80

    EBIT = 100 – 10 = 9 – 18 = 80

    BOOK VALUE; in reality is that yearly depreciation expenditure creating or


    resulting in any additional cash outflow?
    By subtracting interest I was able to reduce my taxable income which in-turn
    reduced by tax amount. By $2. This 2 USD is my tax benefit/ interest tax shield.

    TAX = 20%

    Interest tax shield= interest * tax rate

    OCF is the return that a company generates for all its capital provider after
    fulfilling all operational obligations

    OCF is the return free of operational obligations.

    Return that free of all obligations = OCF – CAPEX – Net Working capital
    investments

    Capex = capital investments in fixed assets

    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?

    Operational inflow – operational expenses = operational profit

    I’ll have to look into my IS:

    Sales/revenue – all operational expenses (including your COGS, tax) = net


    profit (operational profit)

    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)

    Interest tax benefit = interest * tax rate

    Operational Cash flow/ profit = net profit + interest (1 – T) + Depreciation = 1


    lac

    Sir, in order to for us to remain competitive and become sustainable we need


    to think in-terms of both longterm and short term.

    Long-term sustainability: expand, grow: in order to grow we need to invest


    (capital investments)

    Short-term sustainability: working capital

    Net FA investment = this current period’s investment

    OCF – CAPEX – Net WC Investment = Profit that is free of all obligations

    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.

    Whenever we think of company’s value we need to consider FCFF instead of


    net profit. Because free cash flow is the real profit/ the most practical profit.

    As a value seeking or maximizing entity, you would want profit in a more


    sustainable manner. Profit or return that can stand the test of time. How can a
    company generate stable earnings: growth, diversification, improvement (Capital
    expenditures (CAPEX)) and day to day flexibility (working capital investments). In
    order to achieve the above goals, companies need to make investments: Long-term
    investments and short investments = Capital expenditures (CAPEX) and working
    capital investments

    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.

    Net income + Interest – interest tax shield

    Net income + Interest – interest * T

    Operational Cash Flow

     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

    FCFF of Amazon in FY 2020:

    FCFF = OCF – CAPEX – WC Inv Net = 36200 – 66941 –(-2174) = - 28,567

    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.

    Value = Return/risk or cost

    Risk is cost of generating return.

    Profit = return > cost

    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.

    Pathao (100% equity based company)


    Lenders: 30

    Assets (in order to buy assets the


    business needs money)
    This money is known as capital
    Shareholders: 70
    100

    The business each year generates FCF


    for the capital providers.

    Cash flow to Lenders: 24

    Free Cash flow or Cash flow from all


    assets are earnings that are available for
    all capital providers
    Cash flow to Shareholders: 56
    FCF = 80

    As FCF is distributed among lenders and shareholders. So,

    Cash flow to lenders + Cash flow to shareholders is basically my FCF

    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.

    CFAA or FCF = cash flow to lenders + cash flow to shareholders

    Cash flow to lenders = interest +loan repayment – loan taken

    BRAC

    2019: 12 interest; I repaid additional loan of 3 taka

    Outflow of 12 and an additional outflow of 3


    Cash flow to Shareholders = Dividend + Withdrawal – new share issued
    Taxation:

    Government raises money from 2 main sources:

     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%

     1st 5000 *0% = 0


     4000*10% = 400
     11,000 * 12% = 1320
     20,000 * 15% = 3000
     10,000 * 20% = 2000
     0 * 25% = 0
     Total tax = 6720 USD
     Effective (average) tax = 6720/50,000 = 13.44%

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