Explain which adjustments turn EBIT (pre-interest, pre-tax earnings), EBITDA, net income and operating cash flow (CFO) into FCFF and FCFE
The idea
FCFF can be reached from several starting lines. From net income, add non-cash charges and after-tax interest, interest × (1 − t), then subtract fixed capital investment and working capital investment. From EBIT, take EBIT × (1 − t), add depreciation and subtract the two investments. From EBITDA, take EBITDA × (1 − t), add depreciation × t and subtract the investments. From cash flow from operations, add after-tax interest and subtract fixed capital investment, since CFO already reflects working capital and non-cash items. FCFE is FCFF less after-tax interest plus net borrowing. Working capital excludes cash and short-term debt. A frequent trap under US GAAP is forgetting that interest paid is inside CFO and must be added back for FCFF, and under IFRS interest paid may be classified as operating or financing, so check where it sits before adding it back.
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