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Ch10 Example 6 – Free cash flows

Home › Forums › Ask CIMA Tutor Forums › Ask CIMA F3 Tutor Forums › Ch10 Example 6 – Free cash flows

This topic contains 4 replies, has 2 voices, and was last updated by  furgus 7 months ago.

Viewing 5 posts - 1 through 5 (of 5 total)
  • Author
    Posts
  • July 4, 2018 at 8:05 am

    furgus
    Participant

    Hi, please will you explain why the tax figure in Ch10, example 6 is calculated as 935 x 20% = 187 and not (935 – 170) x 20% = 153.

    Thanks

    July 6, 2018 at 4:15 pm

    P2-D2
    Keymaster

    Hi,

    I suppose the 935 should be the profit before tax and not operating profit in order to make it correct.

    Thanks

    July 21, 2018 at 12:50 am

    furgus
    Participant

    I’ve found a pdf on the CIMA website – Company valuations and free cash flow for students of F3.pdf

    which explains how to deduct tax in each case

    When calculating Free cash flow to all investors you
    Deduct Tax (excluding tax relief on interest) (PBIT x tax rate)

    which is what you have in the solution (apologies for questioning this previously)

    When calculating Free cash flow to equity you
    Deduct Tax for the year (PBIT – interest) x tax rate

    I think maybe the tax saving on interest should be added after the Free cash flow to all investors line, in a sense that you can’t have a tax saving on interest until you’ve deducted the interest. I’ve put the two calculations below so it’s clear. I think it must be in there somewhere because of the different way each free cash flow calculation deals with the tax deduction. Does this make sense?

    $000s
    Profit before interest and tax (operating profit) 935
    Less: Tax (20% x (935-170)) (153)
    Add: Depreciation (non-cash) 120
    Less: Investment in non-current assets (420)
    Less: Investment in working capital (185)
    Less: Interest (170)
    ——–
    FREE CASH FLOW TO EQUITY 127
    ——–

    $000s
    Profit before interest and tax (operating profit) 935
    Less: Tax (20% x 935) (187)
    Add: Depreciation (non-cash) 120
    Less: Investment in non-current assets (420)
    Less: Investment in working capital (185)
    ——–
    FREE CASH FLOW TO ALL INVESTORS 263
    Less: Interest (170)
    Add: tax saving on interest (20% x 170) 34
    ——–
    FREE CASH FLOW TO EQUITY 127
    ——–

    July 21, 2018 at 12:53 am

    furgus
    Participant

    I tried to lay the calculations out clearly but it deleted my spacing so it’s not at all clear. I hope you can see what I was trying to do.

    July 21, 2018 at 1:38 am

    furgus
    Participant

    I’m starting to doubt my understanding again. This looks like the free cash flow to debt holders is interest less tax on that interest (at the business rate of tax) which seems odd. If you don’t put the 34 there where else would you put it?

  • Author
    Posts
Viewing 5 posts - 1 through 5 (of 5 total)

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