How do you calculate Free Cash Flow to the Firm (FCFF) from scratch?
A core Valuation interview question — asked in analyst and associate interviews across IB, PE, and the Big 4.
THE SHORT ANSWER
Start with Net Income, add back Depreciation & Amortization (non-cash charges), subtract Capital Expenditures (maintenance and growth), subtract the increase in Operating Working Capital (excluding cash and debt). Then add after-tax Interest Expense (Interest * (1 - tax rate)) to remove the financing effect. Alternatively, start with EBIT * (1 - tax rate), then add D&A, subtract CapEx, and subtract change in working capital. The result is FCFF, the cash available to all capital providers.
WHAT INTERVIEWERS LISTEN FOR
- ✓Start from Net Income or EBIT
- ✓Add back D&A
- ✓Subtract CapEx and change in working capital
- ✓Add after-tax interest (if starting from Net Income)
COMMON MISTAKES
- ✗Forgetting to add back D&A
- ✗Using pre-tax interest
- ✗Including cash in working capital
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