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Hi John,
For question Vogel, the free cash flow of department B was calculated as below
Current share of PBDIT (0.4 × $37.4m) 14.96
Less: PBIT attributable to Department C (10% × 14.96) (1.50)
Less: tax allowable depreciation (0.4 × 98.2 × 0.10) (3.93)
Profits before tax 9.53
Tax (20%) (1.91)
Free cash flows 7.62I dont understand why we did not add back the tax allowable depreciation of 3.93 to the 7.62. It is not cash, and also the normal formula for FCF also add back depreciation as well.
One more question is that in the note 6 of the question itself, it stated: “It can be assumed that the amount of tax allowable depreciation is the same as the investment needed to maintain Ndege Co’s operations”. I dont really get to understand what does this mean? My guess is that it the investment it is mentioning here meant the investment into capex. If that is the case, shouldn’t the calculation of FCF to add back another element of capex investment (equal to tax allowable depreciation)?
Thank you
I explain this in my free lectures, because it is something that the current examiner usually has in questions (and assumes, even if it isn’t mentioned in the question).
Investment to maintain operations means that there is a cash outflow. Since this is equal to the amount of the depreciation, it means that the depreciation is added back and then the same amount is subtracted – so the net effect is simply not to add back the depreciation and not to subtract the same amount.
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