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Dear Sir,
In Dec 2010 Q4 (Lamri Co), the FCFE (dividend capacity), the tax is calculated after deducting the interest cost from operating profit.
However, in June 2012 Q1 (Nente Co), the finance cost is not deducted when calculating the tax (ie, tax is calculated on PBIT) even though the question says “corporation tax of 20% on profits after interest”.
Please be kind enough to explain why this is. I am posting this query as I could not find an existing answer to this, so my apologies if this was answered already. Many thanks in advance!
If you are calculating FCFE (as in Lamri) then you are after the cash available for shareholders – which is after interest payments (and the associated tax effect).
If you are calculating FCF to the firm (as in Nente) then you ignore interest payments (and the associated tax effect) because you are looking at the cash available for all investors (equity and debt) and discounting at the WACC effectively takes account of the after-tax interest (because the cost of debt is included in the WACC).
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